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ECONOMICS 



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THE MACMILLAN COMPANY 

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ECONOM ICS 

AN INTRODUCTION 
FOR THE GENERAL READER 



BY 
HENRY CLAY, M.A. 



Ncfa gorit 

THE MACMILLAN COMPANY 

1918 

jill rights reserved 



A 






Copyright, 1918, 
By the MACMILLAN COMPANY. 



Set up and electrotyped. Published September, 1918. 



OCT -1 ibid 



Nortoonti ^me 

J. S. Gushing Co. —Berwick & Smith Co. 

Norwood, Mass., U.S.A. 



©GU5y6003 









TO 



ALBERT MANSBRIDGE 



PREFACE 

An apology is needed for adding another to the large num- 
ber of books that attempt to deal with the whole subject 
matter of Economics in a single volume. I offer two pleas 
in extenuation. The first is that nearly all existing introduc- 
tions to the subject are intended primarily for the University 
student. The pious wish is generally expressed that they may 
be of use also to the general reader ; but the general reader's 
special needs and opportunities are seldom borne in mind. 
His needs are different, inasmuch as he has not the guidance 
of a teacher and the leisure of the student ; on the other hand, 
his opportunities are some compensation for these disadvan- 
tages, since he has usually a practical interest in the economic 
system and an experience of its working, which the academic 
student lacks. It seemed, therefore, worth while to try to do 
for the economic organization as a whole what Bagehot and 
Mr. Hartley Withers have done for a part of it, the credit 
system — to explain the principles of its construction and 
working in the language of ordinary life, and with reference 
to the experience and interests of the ordinary man. While 
it would need a Bagehot to succeed, I hope that the mere 
attempt will have done something to make it easier for the 
general reader to perceive the bearing of economic studies 
on the political and social problems in which he is interested. 

My second plea is that existing introductions to Economics 
give the student too little help in applying its conclusions, 
since they give too little attention to the most interesting 
and important part of the subject, that, namely, where it 
borders on the aUied studies of PoUtics and Ethics. The in- 



viii Preface 

stinct which leads the working-man in discussions on economic 
questions to return constantly to the ethical aspect of them 
is a sound one, and Economics will gain rather than lose in 
authority by discarding its Mid-Victorian pose of the one and 
only science of society. No study of Economics, therefore, 
it seems to me, is worth making which does not include some 
consideration of the relation of the economic organization to 
political and ethical aims and standards ; which does not, in 
other words, indicate what light Economics can throw on 
Ruskin's question, "What is Wealth?" Hitherto economists 
have tended to confine themselves to explaining how the eco- 
nomic organization works, postponing indefinitely the con- 
sideration of its political and ethical aspects ; moralists, on 
the other hand, have applied their rules to the criticism of 
the economic organization without taking too much trouble 
to understand it first. The chapters of my book, therefore, 
dealing with the political and ethical aspects of the economic 
organization, which to some may seem irrelevant, seem to 
me to deal, however inadequately, with the most important 
section of economic studies ; at the same time I hope that 
any moralist who may take up the book will read the first 
nineteen chapters first. 

I am conscious that my first plea has lost much of its force 
by the publication of Dr. Cannan's Wealth, and my second 
by that of Mr. J. A. Hobson's Work and Wealth. Unfor- 
tunately for me, I did not know that these books were being 
written ; they were not published until this book was almost 
completed, and I did not read them until it was quite com- 
pleted. I trust that the importance of the subjects, and the 
differences in my treatment of them, will be considered suf- 
ficient to justify another book. 

I wish to acknowledge my debt to previous writers. If I 
do not go beyond a general acknowledgment, it is due not 
to any wish to conceal an obligation, but solely to the impos- 
sibility, after seven years of teaching, of tracing to their 



Preface ix 

sources all conceptions and arguments that I owe to other 
writers. It is easier to assess one's indebtedness to friends. 
Professor D. H. Macgregor has helped me with many diffi- 
culties. Mr. R. H. Tawney and Mr. G. H. Thompson read 
my first draft of Chapters II to VI and XII and XIII, and 
helped me with their criticisms and suggestions. Mr. H. 
Sanderson Furniss read the whole of my manuscript with a 
care for which I cannot thank him sufficiently, and enabled 
me to remove a great many obscurities, errors, and other im- 
perfections. My wife performed a similar service while the 
book was being written, and Mr. A. E. Zimmern when it was 
in proof. My thanks are due to the Tutorial Classes Com- 
mittee of the University of Oxford for relieving me of lecturing 
work, and so enabling me to give the book the revision for 
which it had been waiting a year. And I thank, though they 
are too numerous to mention by name, all the members of 
my classes, who have allowed me to draw on their wide and 
diverse industrial experience, and have helped me with their 
criticisms of the views, my own and other people's, that I 
have put before them. 

H. C. 



PREFACE 

The outstanding characteristic of Henry Clay's Economics 
for the General Reader is its readableness. Beyond a certain 
point the involved questions of economic theory cannot be 
simplified. Some writers of economic textbooks seem to 
have supposed that condensation and simplification were 
synonymous terms ; others have attempted to hide theory 
behind alluring description on the apparent assumption that 
the theory would be swallowed more or less unnoticed. Pro- 
fessor Clay, on the other hand, recognizes frankly that "eco- 
nomics" means "economics," but he has produced a unique 
book because in its preparation he bethought himself con- 
stantly of the needs of the general reader — the reader who 
can understand a clear presentation of what is clear in the 
author's own thought, but who wishes nevertheless to be re- 
lieved of the task of carrying in his mind a highly technical 
jargon or specialized nomenclature. 

To begin with Professor Clay knows his economics. Sec- 
ondly, his experience as a teacher has supplied him with fruit- 
ful suggestions of method and of illustration; thirdly, his 
capacity as a writer has enabled him to present what he has 
to say with delightful ease and clearness ; lastly, his avoid- 
ance of unnecessary technical phraseology spares the general 
reader the anxiety and uncertainty that arise from a possible 
misinterpretation of unfamiliar terms. 

Because of its obvious merits Professor Clay's book has 
already been adopted as a text by a number of college teachers 
of economics. But from the American point of view its draw- 
back lay in the distinct appeal it was intended to make to a 



xii Preface 

British public. The illustrations, the criticisms of social and 
economic organization, the proposals for reform, etc., were 
all drawn from or intended to apply to British experience. 
It seemed wise, therefore, before introducing the book broadly 
to the American public, to have a special American edition 
prepared. In undertaking the preparation of this edition the 
undersigned wished, of course, despite some differences in view, 
to interfere as little as possible with the author's presentation. 
In no case, it is beUeved, has any change in theory or in gen- 
eral economic philosophy been introduced. English examples 
were replaced with American examples and concrete matter of 
purely British interest has been deleted. In several cases, 
however, where an English illustration seemed peculiarly apt 
or where it could not without substantial sacrifice be sup- 
planted with an example drawn from American life, the origi- 
nal was left unchanged. It is hoped, therefore, that in this 
American edition Professor Clay's general plan has not been 
interfered with, and, indeed, that appreciation of it by the 
reader on this side of the water may, because of the revision, 
be enhanced. 

Eugene E. Agger. 
Columbia University, 
May, 1918. 



CONTENTS 

Chapter I. — Introductory 

PAGE 

1. Scope and Subject Matter of Economics . . . i 

2. Relation of Economic Study to Business Experience . 6 

3. The Method of Economics 9 

4. The Limits of Economics 15 

Chapter II. — The Division of Labor 

1. The Economy of Specialization . . . . . .21 

2. Machinery , 24 

3. The Localization of Industries 27 

4. Large-scale Production, and the Limits of Specialization 31 

5. The Evils of Specialization 38 

Chapter III. — The Organization of Production 

1. The Coordination of Specialists 46 

2. The Functions of the "Middleman" .... 48 

3. Methods of Appointing the Organizers of Production . 53 

4. Merits AND Defects of THE System OF " Free Enterprise " 58 

Chapter IV. — Speculation and Insurance 

1. Production as a Whole Carried on in Anticipation of 

Demand 64 

2. Speculative Dealing 67 

3. The Use of Contracts to Shift Speculative Risks on to 

THE Shoulders of Dealers 73 

4. Terminal Markets for Dealing in Futures ... 78 

ziii 



xiv Contents 

PAGE 

5. Illegitimate Speculation 83 

6. Insurance and Other Methods of Meeting Risks . . 88 

Chapter V. — Capital and Its Organization 

1. Functions of Capital in Modern Industry and Commerce 92 

2. Conditions Requisite for the Accumulation of Capital 94 

3. Different Types of Organization for Applying Capital: 

the Private Firm, the Joint Stock Company, Coopera- 
tive AND Public Enterprise 97 

4. The Market for Capital 105 

Chapter VI. — Competition and Association 

1. The Pervasive Influence of Competition . . . 107 

2. Conflicting and Common Interests Arising from Com- 

petition Ill 

3. Combination and Trade-Unionism ; the Cooperative 

Movement and Municipal and National Trading . 1x5 

Chapter VII. — Monopoly and Combination 

1. In Certain Industries Economy and Efficiency Can Be 

Secured Only by Monopolistic Control . . .123 

2. Railways May Be Classed with These Industries . .127 

3. Methods of Social Control of These Industries . .129 

Chapter VIII. — Monopoly and Combination {Continued) 

1. The Tendency to Monopolistic Combination . . .137 

2. Conditions Favorable to Monopolistic Combination . 143 

3. Difficulties of Monopolistic Combinations . . . 146 

4. Advantages of Monopolistic Combination . . . 148 

5. Vertical Combination 152 



Contents xv 
* Chapter IX. — Money 

PACE 

1. Money and Coinage 153 

2. The Single Standard 158 

3. Gresham's Law 161 

4. Paper Currency 163 

Chapter X. — Banking and Credit 

1. The Canceling of Indebtedness by the Use of Credit 

Instruments 169 

2. The Creation of Credit by Banks 171 

3. The Cash Reserve 180 

4. The Social Utility of the Credit System . . .188 

>/ Chapter XI. — The Level of Prices and Foreign 
Exchanges 

1. The Measurement of Changes in the Level of Prices 195 

2. Causes of Changes in the Level of Prices . . .198 

3. The Law of Comparative Cost 204 

4. Imports Paid for by Exports 207 

5. The Balance of Trade and the Level of Prices . . 209 

Chapter XII. — The Circulation of Wealth 

1. Wealth and Production 214 

2. Income and Capital 218 

3. Spending and Saving 221 

4. The National Dividend or Income 223 

Chapter XIII. — Unemployment and Overproduction 

1. Imperfect Cooperation between Specialists . . .229 

2. Imperfect Anticipation of Demand 233 

3. Cycucal Trade Fluctuations 236 



xvi Contents 

Chapter XIV. — Value 

PAGE 

1. Value and Price 242 

2. The Labor Theory of Valxje 245 

3. The Cost of Production Theory of Value . . .250 

4. Decreasing, Increasing, and Constant Cost . , .256 

5. Influence of Competition and Monopoly on Value . 262 

Chapter XV. — Value (Continued) 

1. Relation of Utility to Value 266 

2. The Marginal Utility Theory of Value . . . .269 

3. The Law of Supply and Demand 273 

^ Chapter XVT. — Wages 

1. Wages and Income 279 

2. Wages and Labor Cost 283 

3. Wages and Trade-Unionism 285 

Chapter XVII. — Wages (Continued) 

1. The Subsistence Theory of Wages . . . . . 289 

2. The Wages Fund Theory of Wages ♦ , . . . 291 

3. Productivity Theories of Wages 293 

4. The Influence on Wages of the Standard of Life . 301 

5. The Influence on Wages of the Volume of the National 

Dividend 308 

6. The Influence on Wages of Inequality of Opportunity 309 

7. Summary 312 

Chapter XVIII. — Interest and Profits 

1. The Distinction between Profits and Interest . .314 

2. Why is Interest paid? 320 

3. What determines the Rate of Interest? . . . -324 



Contents xvii 

Chapter XIX. — Rent 

PAGB 

1. The Ricardian Theory of Rent 328 

2. The Law of Diminishing Returns or Increasing Cost . 330 

3. Rent and Cost of Produciion 334 

4. Application of the Ricardian Theory to Actual Con- 

ditions 337 

Chapter XX. — Rent (Contintted) 

1. "Rent" Elements in Wages 341 

2. "Rent" Elements in Profits and Interest . . . 345 

3. Social Implications of the Ricardian Theory of Rent . 350 

Chapter XXI. — The State and the Economic 
Organization 

1. Private Property and Freedom of Enterprise . -355 

2. State Regulation and Supersession of Freedom of Enter- 

prise 359 

3. Taxation 364 

Chapter XXII. — The State and the Economic 

Organization (Continued) 

1. The Assumptions of the Present System . . .370 

2. The Assumption of Rational Self-interest . . .372 

3. The Assumption that Competition Leads to the Survival 

of the Fittest 374 

4. The Assumption that Wealth Will Usually Be Associ- 

ated with Social Service 377 

5- The Assumption that Market Value is a Satisfactory 

Indicator for Production to Follow . . . 383 



/ -^ 

xviii Contents 

Chapter XXIII. — Wealth and Welfare — the Measure- 
ment OF Wealth 

FA6B 

1. Wealth as Product 389 

2. Wealth as Welfare 393 

3. Defects in the Usual Method of Computing the Country's 

Wealth 396 

Chapter XXIV. — Wealth and Welfare — Economic 
Influences on Welfare 

1. The Influence of Distribution 401 

2. The Influence of the Use of Wealth and the Kjnd of 

Product 404 

3. The Influence of Work 408 

4. The Sacrifice of Producer to Product . . . .411 

Chapter XXV. — Wealth and Welfare — Business and 
Morality 

1. Welfare regarded as Independent of Wealth in Some 

Systems of Morality 418 

2. The Economic Organization not Necessarily a Reflec- 

tion OF Current Moral Standards .... 420 

3. Reaction of the Economic Organization on Moral Stand- 

ards 425 

4. Materialistic Tendency of Economic Influences To-day 430 

5. How Wealth Contributes to Welfare .... 434 

6. "Business is Business," and Economic Laws . . . 438 

7. The Moralization of the Economic Organization . . 442 



ECONOMICS 



ECONOMICS FOR THE GENERAL 
READER 

CHAPTER I 

INTRODUCTORY 

I 

The Scope and Subject Matter of Economics 

Definition. — Economics is the study of business in its 
social aspect ; the word " business " being used in its broadest 
sense, to cover all lawful ways of making a living. It wiU 
help us to reach a clear understanding of the scope and objects 
of the study if we take an example of the simplest kind of busi- 
ness transaction, and remind ourselves of the social arrange- 
ments which make the transaction possible. 

Example of Modern Business. — We will take the pur- 
chase of a woolen shirt, the price of which is $2.50. We 
notice first of all that it is not made in the home, as it would 
have been a couple of generations ago ; it is less trouble to 
buy it from an outfitter. The outfitter did not make it ; he 
bought his stock of shirts from a shirt manufacturer, or pos- 
sibly from a wholesaler who bought them from a manufacturer. 
When we say the shirt manufacturer " made " the shirts, 
however, we do not mean that he made the material of which 
the shirts are made ; he may have done so, but more prob- 
ably his business was confined to " making up " material 



2 Economics for the General Reader 

which he bought from a jobbing-house or flannel manufacturer. 
From other merchants or manufacturers he would buy the 
thread, buttons, and material for collar-bands. The flannel 
manufacturer would use several kinds of yarn in making his 
flannel, and each of these yarns would be spun from several 
kinds of wool. The origin of the shirt, then, which we ob- 
tained by the simple process of handing $2.50 over a counter, 
is to be sought on the grazing lands of the West, on the sheep 
runs of AustraHa, and on the South American plains, where 
the wools were grown, in the cotton plantations of the South 
which supplied the raw material for the thread and collar- 
band, and in New York and other centers where the buttons 
were made. In the course of its journey from the sheep's 
back to ours, the wool has probably traveled through three 
or four factories, through a dozen middlemen's hands and half 
round the globe. It is one item in the output of an organiza- 
tion, the woolen industry, the ramifications of which reach 
most parts of the civilized world. 

The woolen industry was not the only organization involved 
in the production of the shirt, and necessary to its production 
on the modern system. Each of the factories through which 
the material passed required for its work on the material many 
machines, which in their turn required power to drive them. 
Several branches of the machinery and engineering industries 
were therefore involved in the making of this shirt ; so were 
the iron and steel industries, which supplied the material of 
these machines ; so were the oil and leather industries, since 
they supplied subsidiary materials. The coal industry was 
involved, because coal is the chief source of power ; the build- 
ing trades, because modern factories and warehouses have to 
be built specially for their work. The more important forms 
of transport were all of them employed in the making of this 
shirt, since its materials came from so many different quar- 
ters, and were shaped and put together in so many different 
places. The credit system was probably involved, since some 



Introductory 3 

of the firms that handled it would be dependent on assistance 
from banks to carry on their business, and the movement of 
raw materials is very largely financed by credit instruments. 
It would hardly be too much to say that the apparently 
simple transaction of purchasing a shirt was the completion 
of a process in which the modern economic system as a whole 
was involved. 

Moreover, when we spoke of the parts of that system, 
manufacturers and merchants, transport agencies and the 
credit system, we were referring summarily and simply to 
things which in themselves are complex. The flannel manu- 
facturer employs eleven or twelve different kinds of worker 
in four departments, even if he neither spins his own yarn 
nor dyes his own pieces ; the clothier employs ten different 
kinds of worker on three or more different machines in five 
or more departments ; transport agencies vary from the coun- 
try carrier with a horse and cart to railway companies with 
100,000 employees and $500,000,000 capital ; even the mer- 
chant, who employs directly only half a dozen clerks in a 
modest office, may be the meeting-point and support of a 
network of trade coimections covering a continent ; even the 
outfitter's business requires an expert. The shirt, then, 
which we purchase with so little thought, is a product of the 
most comphcated piece of social organization that mankind 
has yet devised. Our attempt to get beliind the superficial 
simpUcity of our business transactions has entangled us in a 
labyrinth, the paths of which lead into every social class, and 
has involved us in a study of a large part of the activities of 
the human race. 

This system of social arrangements, the existence of which 
is revealed by the analysis of any business transaction, is the 
subject matter of Economics ; it is the object of Economics 
to explain the arrangements in detail and to show how the 
system works. The example we have taken (and any other 
would have served as well) justifies the use of the word " sys- 



4 Economics for the General Reader 

tem." At first sight the business world offers a spectacle 
of confusion rather than order. We found however that 
things did not happen anyhow. The materials of which our 
shirt was made could not have found their way from the 
place of origin, through all the processes of manufacture, to 
the outfitter's by accident. There was order in the process: 
the outfitter's shop, the shirt-maker and the other firms con- 
cerned were parts of a working system ; our transaction was 
one of milHons which depend on one another. Our ghmpse 
of the working of the system gave the impression of a great 
automatic machine. The system is not a system Hke the 
political system, which has a sovereign directing authority. 
It is not the work of a single brain or the embodiment of a 
single purpose ; it is a spontaneous organization, the outcome 
of actions which were not consciously directed to establishing 
or maintaining it. Hence, although we are parts of it, we 
can study it objectively, like a piece of external nature, and 
search for the principles of its structure and working as 
the physiologist searches for the principles of the structure 
and working of the human body. What points of contact 
this economic order has with the political order, and how 
far it harmonizes with the moral order, are questions we 
can ask when we have examined it and ascertained its 
principles. 

Interest and Importance of Economics. — The example we 
took will illustrate also the interest and importance of 
Economics. Why was the shirt $2.50? Why did the out- 
fitter charge us no more ? How is it that we could not get it 
for less? Who gets our $2.50 and all the other dollars paid 
for shirts? In what proportions is the price divided among 
the different firms which handled the goods? and, within 
each firm, between operatives and employers? On what 
principles does this division take place ? These are questions 
which every one tries to answer at some time or other, and 
Economics is only a systematic attempt to answer these and 



Introductory 5 

related questions. How do the many firms which contribute 
to the making of the shirt manage to carry on between the 
time when they incur the expense of making the shirt and the 
time when the user pays for it ? How are payments made in 
England and Australia for goods sent to the United States, 
and what difference do protective duties on imports into the 
United States make on the course of trade ? What would be 
the effect on the price of shirts of a rise in wages, or a new tax 
on profits or rents? What would be the effect of applying 
minimum-wage acts to all the industries concerned in the 
making of a shirt? or of the formation of a " combine " of 
shirt-makers or flannel manufacturers? Is a "combine" 
probable in either of those industries? Under what condi- 
tions is an industry likely to be " trustified "? These are 
less obvious problems which our example presents — less ob- 
vious, but still the kind of questions that the investor, the trade 
union oflGicial, and every citizen who uses his vote intelli- 
gently is constantly being called upon to face ; and all of 
them fall within one or other of the more important sections 
of Economics. 

The system works ; and even if we take its working for 
granted without inquiring how it works, its defects compel 
study. Unemployment, speculative gambling, waste and 
poverty, are results of it obvious to the most superficial 
observer. Are these evils inevitable? If they are, what 
advantages does the system offer to counterbalance them? 
if not, why are they there? Above all, what is one's personal 
responsibility in the face of these evils? Economics is the 
systematic study of these questions. Some study of Econom- 
ics is at once a practical necessity and a moral obligation. 
And as a matter of fact everybody makes some such study, 
everybody at some time or other is a student of Economics, 
an economist ; like M. Jourdain, who was surprised to learn 
that he spoke prose, the general reader may not have realized 
that he was an economist. 



6 Economics for the General Reader 

II 

Relation of Economic Study to Business Experience 

Economic Experience and Study. — Every one, then, makes 
some study, more or less casual or systematic, of the subject 
matter of Economics; and every adult has one important 
qualification for such study, namely experience. It is on the 
basis of their experience of the present economic system that 
people form their judgment on its problems ; it is in their 
experience that they find the materials for answering such 
questions as arose from the example we took of an economic 
transaction. 

Experience, however, while it is a qualification, and an 
essential qualification, for the study of economic problems, 
cannot be an adequate substitute for that specialized and 
systematic study of them which constitutes the science of 
Economics. It is easy to be familiar with a thing, and 
even to work with it, without understanding it. The loco- 
motive engineer can do his work excellently without knowing 
anything of the science of thermo-dynamics, and most of 
us succeed in spending a lifetime with our bodies without 
acquiring any considerable knowledge of the science of human 
physiology ; similarly a man may be a good business man and 
yet a bad economist. The experience which any one man, or 
even any one social class, gains of the economic system in 
the course of everyday life and work is limited. So far as 
it goes, it is a sound basis for economic judgments; but a 
thorough practical acquaintance with banking would not 
help a man much to understand the organization of a colliery, 
an intimate knowledge of the building trade would not fit a 
man to understand, either in their private or their social 
aspect, the operations of a cotton-exchange-broker. To fijid 
a secure basis for an understanding of the economic system it 
is necessary to bring together the experiences of all trades 



Introductory j 

and occupations, of manual worker and industrial organizer, 
of private industry and government service, of housewife 
and producer ; the experience of any individual or class is 
too limited to give by itself anything but a limited and partial 
insight into the system as a whole. 

Instinctive Nature of Experience. — Moreover, the under- 
standing of a system that a man gains from the experience of 
being a part of it is more of the nature of instinct than knowl- 
edge. It enables a man to judge and act ; it does not enable 
him to explain always how he judges and why he acts. If 
forced to give an explanation, the explanation may be a wrong 
one ; copybook maxims about industry and early rising have a 
suspiciously large place in the explanations given by self- 
made men of their success ; luck and a lack of scruple, though 
at least as important, are never mentioned. Thus the 
experience of people actually engaged in industry has to be 
subjected to their own reflection and studied from outside, 
to be analyzed, before it can add anything to the body of 
knowledge which all may share who are willing to study; 
treated in that way it becomes the most valuable of all sources 
of knowledge. 

Limitations of Experience. — Individual experience is 
limited and unconscious ; it has to be supplemented by 
Economics for a more important reason. Its point of view 
is that of the individual, the point of view of Economics is 
that of society. Every business transaction has more than 
one aspect. The individuals who are parties to it are in- 
terested chiefly in its private aspect ; Economics is concerned 
with its social aspect, which may be a different thing. From 
the point of view of the individual, profits are the difference 
between his expenses and his receipts ; from the point of view 
of society, they are the incentive to, and the payment for, 
organizing work ; the individual is concerned only with 
their amount, society with their origin and the extent to 
which they eHcit and represent services to society. Specula- 



8 Economics for the General Reader 

tion, from the point of view of the individual, is the act of 
buying at one time and selling at another, and is justified 
if the selling price exceeds the buying price ; from the point 
of view of society, it is the process by which fluctuating sup- 
plies are adjusted to a fluctuating demand, and is justified 
(or the reverse) by its influence on price fluctuations. To the 
individual it may make little difference whether he increases 
his profits by higher prices on a smaller output or by a larger 
output at lower prices ; society is keenly interested to learn 
under what circumstances the former method is likely to be 
adopted and under what circumstances the latter. There is 
the same difference between the two views as there is between 
the view of a town which a man gets from his street-door and 
the view he would get from an air-ship. No one, un- 
fortunately, can Hft himself into a position to take an " air- 
ship " view of society ; so that the economist, and other 
students of society, have to construct their " air-ship " view 
of society by collecting, comparing and relating a large number 
of street-door views. 

Importance of Social Viewpoint. — Economics, we have 
said, is the study of business in its social aspect, and the point 
of view is fundamental to the study. Business in its private 
aspect is so much a matter of personal character and accidental 
circumstances, that only a very small part of it can be reduced 
to rule or stated in systematic form. University courses and 
even degrees in " Commerce " can now be taken, but the 
study of Economics, as defined above, can help the future 
business man only by making him more interested in business 
and therefore more Hkely to devote his undivided energies to 
it. From the point of view of society's interests, however, 
it is very desirable that business men should study Economics, 
since it is to society's interest that they should reflect on and 
realize the social effects of their private actions. For the 
same reason that the private and the social aspects of business 
are so often different, a " goverimient of business men " — 



Introductory 9 

if the phrase is intended to be understood in a narrow sense — 
would be a bad government. It would apply to the work of 
government standards and tests derived from private industry 
that are not appHcable to public services ; it might forget 
that it often " pays " a government to run a public service 
(such as sanitation or education) " at a loss." 

Ill 

The Method of Economics 

The study, then, of our subject matter, in which every 
one at some time or another engages, can be supplemented 
with advantage by the specialized and systematic study of 
it, which we call Economics. The latter grows out of the 
former, the former is the best preparation for the latter. 
And the method of the unconscious and unsystematic study 
is the method, used deliberately and consciously, by which 
the systematic study reaches its conclusions. That method 
is — to reflect ; to generalize on the basis of the known 
facts ; in the light of the generalization to collect further 
facts with which to test it; and by this process of testing, 
and by comparison with other generalizations reached by 
the same process, to reach a generalization which exactly 
fits the facts. By this method any one who is forced by 
circumstances to frame an answer to some economic problem 
brings his experience and casually accumulated knowledge to 
bear upon it ; by this method Economics seeks to reach and 
to state the principles of the present economic system. 

Nature of Economic Theory. — Economic Theory is the 
body of generalizations so reached. The practical man is 
suspicious of " theory." His suspicion is justified, if 
" theory " is used as a substitute for ascertainable facts. 
But generalization, the making of theories, is unavoidable. 
Facts do not explain themselves. In some problems, the 



lO 



Economics for the General Reader 



causes of trade fluctuations for example, the multitude of 
facts is so great that we cannot even begin to collect them 
unless we collect on some plan ; we shall be overwhelmed if 
we do not take with us to the facts some coordinating idea ; 
in other words if we do not frame a theory and take it to the 
facts to test it by them. On some important questions we 
cannot hope to enumerate all the ascertainable facts ; if we 
wait to form our judgment on the influences that fix wages 
until we have examined all the ascertainable facts, we shall 
never form a judgment, their number is so great. On other 
problems some decision has to be reached for purposes of 
action, although facts are scarce or unobtainable ; taxes are 
often based on theories which it has been impossible to verify, 
the collection of the taxes subsequently eliciting the facts 
that are needed to verify the theories. 

Again facts may be contradictory, at any rate on the 
surface : it is a fact that the introduction of labor-saving 
machinery has on many occasions displaced labor; it is 
also a fact that the amount of labor-saving machinery in 
use has steadily increased for generations without being 
accompanied by any corresponding increase in the propor- 
tion of the population unemployed. Or the facts may bear 
more than one interpretation. There are several conflicting 
theories of wages, all of them "based on facts" : for example, 
according to the theory on which English Poor Law policy is 
based, any subsidy to the wage-earner from the State will 
force wages down; according to the theory on which the 
feeding of school-children and old age pensions are based, 
State subsidies have no effect, or only a negligible effect; 
some facts can be found to support either theory. On the 
same foundation of facts different statesmen have based two 
entirely different fiscal policies in regard to foreign trade. 
Facts are seldom simple and usually complicated ; theoretical 
analysis is needed to unravel the complications and interpret 
the facts before we can understand them. 



Introductory il 

Theory and Practice. — The practical man's objection to 
" theory " is a valuable protest against hasty generalization 
on an insufficient basis of fact or on an inadequate survey of 
available facts. But the opposition of " facts " and " theory " 
is a false one ; their true relation is complementary. We 
cannot in practice consider a fact without relating it to other 
facts, and the relation is a theory. Facts by themselves are 
dumb ; before they will tell us anything we have to arrange 
them, and the arrangement is a theory. Theory is simply the 
unavoidable arrangement and interpretation of facts, which 
gives us generalizations on which we can argue and act, in the 
place of a mass of disjointed particulars. What we are 
seeking in our study of economic problems, whether it is a 
conscious and systematic study or not, are principles. We 
want to know what, in the operations we observe, is the rule, 
what is the exception ; why certain arrangements are as 
they are, and what will happen if we change them. Unrelated 
facts will not answer our questions ; we want chains of facts, 
regularities, relations of cause and effect. We are seeking 
principles in order that we may act on them, because the 
ultimate motive of economic study is not curiosity, but the 
necessity to act, and rational action must be based on some 
principle. All arguments are based on principles, facts 
are of use only as they represent or illustrate principles. 
Economics, therefore, in order to discover the principles on 
which the present system is constructed and operates, surveys 
the facts of the system, arranges them, analyzes them, 
generalizes on the basis of them. Like every other science 
it advances by constantly discarding generalizations which 
newly discovered facts have revealed as unsound or inadequate, 
and devising new generalizations which will cover and explain 
the new facts. 

Conscious and deliberate theorizing is necessary, because 
there is so much unconscious and haphazard theorizing. 
The man who opens a discussion by saying that he is going 



12 Economics for the General Reader 

to " deal with facts not theories " does not mean that he is 
going to refrain from generalization; he usually means that 
he wishes to confine attention to a few facts that support his 
generalization, and to ignore all facts that conflict with it. 
The field of political controversy is strewn with hasty generali- 
zations treated as if they were established truths, and used as 
the basis of argument. " Trade follows the flag," " Wages 
depend on the cost of living," " The present competitive 
system," are examples; and even more insidious are the 
theories of wages, profits, value, exchange, on which people 
base their judgment of economic problems without ever 
formulating them even to themselves. The time-honored 
" Law of Supply and Demand " has been misused so long to 
justify quiescence in the face of obvious evils that a natural 
reaction has led to the view that it can be ignored. 

Individual Presuppositions and Theory. — One of the great 
difficulties of all study of which man and his activities are the 
subject matter is that the student, being himself part of the 
subject matter of the study, is likely to be influenced in his 
judgments by assumptions, based on interests and prejudices, 
of which he is unconscious. The danger is particularly great 
in the study of the economic system, and the most careful 
student can hardly hope to attain a perfectly impartial judg- 
ment. It is doubly important, therefore, that economic 
theorizing should be carried on " in the open," that the 
assumptions underlying economic policies should be brought to 
light, and the " views " (or unconscious theories) on which 
people in practice base their judgment of problems of wages, 
prices and other things, should be stated explicitly, in order 
that they may be critically examined. If everybody is, as 
has been said, an economist, certainly everybody has his own 
economic theories; if those theories are not formed by con- 
scious and deliberate study, they will be based on a limited 
experience and on prejudices, interests, ideals, which mislead 
the judgment just because they are unsuspected. An in- 



Introductory 13 

cidental advantage of deliberate study is that it leads people 
to define their terms. Such words as Wealth, Value, Profits, 
Monopoly, Competition, Cooperation, can be used in more 
than one sense each, and the different senses are not distin- 
guished clearly in ordinary conversation. Economics, by 
confining each word to a single sense, and defining that sense, 
makes progress in argument possible, and tends to prevent 
those lengthy controversies, so frequent in politics, which are 
lengthy only because the parties to them mean different things 
by the same words. 

Complexity of Economics. — The twofold difficulty of 
handling the multitude of available facts and collecting addi- 
tional facts, where relevant and decisive information is not 
already available, has produced a tendency to spKt up the 
subject matter of Economics, into a large number of smaller 
studies. It has been possible by so doing to utilize more 
fully the collections of facts made by government depart- 
ments, congressional commissions and private inquiries, to 
supplement them, and so to deal exhaustively with particular 
problems, such as unemployment and the minimum wage, or 
particular developments of industrial structure, such as the 
trust movement and cooperation. Recent work in Economics 
of this character has an immediate influence on social 
poUcy by indicating the need and method of particular 
reforms. Such inquiries, however, are supplementary to the 
study of the general characteristics of the economic system ; 
they aid it, they do not make it unnecessary. The different 
problems are interdependent, and can only provisionally be 
treated as separate and independent. Wages cannot be con- 
sidered without some consideration of profits and rent, com- 
binations cannot be studied without considering the nature 
and effects of competition; the system of distribution is 
intimately bound up with the system of production. The 
secondary and less obvious results of changes, therefore, are 
often more important than the immediate and obvious results ; 



14 Economics for the General Reader 

the reactions and repercussions of a new invention, or a piece 
of social legislation, or an innovation in business organization, 
may spread far beyond the immediate objects to which it is 
directed. The economic system, in fact, as our example 
showed, operates as a unity, although its unity may be 
made up of lesser unities ; and the relation of one part to 
another, the bearing of one problem on another, and the 
secondary effects of a limited reform can be understood only 
by studying the system as a whole. Some such attempt to 
understand the system as a whole is, as a matter of fact, 
made by every one; society's economic arrangements so 
intimately affect the political organization of society and 
the moral life of the individual that it is hard to reach a 
decision on any broad political or moral question without 
incidentally judging the economic system. 

Is Economics a Science? — The phrase, "a science of 
Economics," was used above. The claim of Economics to 
that description has been disputed. In the only sense of the 
word " science," however, that matters — the study of a 
group of problems, in which the solution of one assists in the 
solution of the others (J. Cook Wilson) — any study of society 
proves that Economics is a science. The objection is some- 
times made that Economics cannot be a science because 
economists disagree. But doctors disagree, and no one denies 
that physiology and anatomy are sciences. There are dis* 
agreements in every science, yet in every science the advan- 
tages to be gained by specialized study have been proved by 
experience. Adam Smith is regarded as the founder of the 
science of Economics, because he perceived that there was a 
connection between different economic problems, and at the 
same time that economic phenomena were largely independent 
of the poHtical arrangements with which, up to his time, they 
were usually studied. He displayed more clearly than had 
been done before the social cooperation which results from 
the pursuit of their private interests by individuals, and so 



Introductory 1 5 

pointed the way to a specialized study of business in its social 
aspect. 

IV 

The Limits of Economics 

Relation to Other Social Sciences. — This separateness and 
independence of economic phenomena must not be exag- 
gerated. The immediate successors of Adam Smith, under 
the influence of laissez-faire ideals, did so exaggerate it, 
although Adam Smith himself put forward his economics as 
part of a general study of moral and poUtical philosophy; 
it is well, therefore, to recognize at the outset the Umits of 
Economic^. Economics is not a complete philosophy of 
society ; it does not give a complete account even of that part 
of human conduct which it studies. The social relations to 
which business gives rise are the subject matter not only of 
Economics but also of the science of Politics, the study of 
social action in general, and of Ethics, the study of conduct in 
general. And Economics is the subordinate study of the three, 
because the problems of social practice to which its study is 
directed are seldom purely economic, and when it comes to 
action the ethical aspect is always, and the poUtical aspect 
is usually, more important than the economic aspect. The 
study of the economic element in social and political prob- 
lems is essential if they are to be solved, but few of them 
can be decided by purely economic considerations alone. 

An example or two will illustrate the distinction. The 
system of State regulation of industry and commerce known 
as the Mercantile System was condemned by Adam Smith, 
and shown by him to result in waste ; yet he describes a part 
of the system, the Navigation Acts, as the wisest of all our 
commercial regulations, because he attributed English naval 
power to them and considered that the political principle 
that defense is more important than opulence overrode the 



1 6 Economics for the General Reader 

economic consideration of waste. So an American to-day 
might support Protection and preferential tariffs on purely 
economic grounds, thinking that such a policy would 
strengthen and increase his country's trade; but he might 
advocate such a post-war poUcy for all the Allies, while 
believing that it would result in a net loss of wealth to all 
concerned, on the ground that it would knit them together 
against the Central Empires, and that such a political end was 
worth some economic sacrifice. A man may be a socialist on 
purely economic grounds, believing that an extension of State 
ownership would result in cheaper and better supplies ; but 
he may believe that State ownership would result in some 
waste, and still advocate its extension on the political ground 
that so important an influence on life as the supply of the 
means of life should be democratically controlled, or on the 
ethical ground that competition as it works at present is 
immoral. So, again, a legal minimum wage, the public 
provision of better housing, or improved free education may 
be advocated on the economic ground that they would in- 
crease efficiency and, in the long run, more than pay for 
themselves ; or on the ethical ground that society can afford 
them and ought to provide them, whether the result be 
economic loss or gain. 

Or we may put the relation between Economics and Politics 
and Ethics in another way. In every problem there are two 
questions — What is ? and What ought to be ? The problem 
can be dealt with only when both are answered. Economics 
is concerned chiefly with the first ; the second is (or should be) 
decided rather by a consideration of the political and ethical 
aspects of the problem, because our political and ethical 
opinions give us the ends of our actions. Where on political 
or ethical grounds two or more alternatives are admissible, 
then the economic end of cheapness, a maximum return for a 
mim'mum of expenditure, may decide. In practice society 
does not accept this principle in its full rigor, but compromises 



Introductory 17 

between its ideals and cheapness ; in democratic countries 
we rest content with an oligarchic organization of industry for 
fear of " drying up the springs of wealth," and in Christian 
countries we apply the doctnne of brotherly love to economic 
relations only within limits, for fear of being forced ourselves 
to rely for a livelihood on the brotherly love of others. 

Object of Economics. — It should be noted that the object 
of Economics is not the advocacy of the present or of 
any other economic system, but explanation solely. In 
explaining, for example, that competition is the chief force 
controlling industry in the social interest, the economist 
is not saying that it ought to be, or that it is an ideal 
method of control. Explanation is not justification, a truth 
which the classical economists, in the excitement of dis- 
covering how the economic system worked, tended to forget. 

Temporary Character of Conclusions. — Not only is 
Economics a subordinate study, but its conclusions have a 
temporary appHcation only ; they are not, like the conclusions 
of mathematics, true for all time and under all circumstances. 
This is so because they aim at giving a systematic explanation 
of the social arrangements by which man satisfies his wants, 
and these arrangements are temporary and conditional. They 
depend very largely on the state of the physical sciences ; 
for any sudden increase in man's control over nature would be 
reflected in a changed social organization. The social effects 
of the discovery of the use of coal as a source of power, of 
cheap steel, of electric communications, warn us against any 
attempt to forecast the future simply on a basis of the study 
of existing economic arrangements. The arrangements 
depend also on the possibilities of human nature. A religious 
revival, which made the motives of the early disciples the 
dominant motives of society, would produce a sudden re- 
arrangement of economic institutions ; and a theory of dis- 
tribution which gave a true account of incomes to-day would 
become suddenly false. Or a growth of civic patriotism, like 



i8 Economics Jar the General Reader 

that of the Athenians, would make possible economic arrange- 
ments which, as men are, would not work. Those economists 
who have approached the study of economic arrangements 
from the standpoint of psychology have concerned themselves 
more with measuring the strength of motives than with dis- 
tinguishing and classifying the kinds of motives which actuate 
men 'in their economic relations and estimating their com- 
parative importance. The latter is a field that needs ex- 
ploration. 

In emphasizing so strongly the limits of Economics we are 
not underrating its importance. We wish merely to guard 
against the confusions which invariably arise when some 
subject of everyday experience is subjected to scientific 
examination. The economist is constantly accused of saying 
that things ought to be as they are, when he merely points 
out that they are. On the other hand, where his authority is 
recognized, he is constantly quoted as the final authority on 
all social questions, whereas Economics is concerned with 
only one aspect of social questions. Though subordinate, 
Economics is not unimportant. In answering the first of the 
questions that face us in every social problem — the question 
What is ? — Economics can give perhaps more help than any 
other study. The widely varying views of the nature of the 
economic system which are held by people who play an im- 
portant part in working it are sufficient indication of the diffi- 
culty of the question. And it is as important as it is difficult. 
It is only by understanding the present system that we can 
make with a minimum of dislocation the transition to the 
different system which our political and ethical ideas dictate ; 
and the less the dislocation which a social reform involves the 
less is the danger of reaction following the reform. There 
is no need, however, to emphasize further the importance of 
the economic aspect of social arrangements ; everybody 
experiences it. And the economic end of cheapness or plenty 
is sufficiently important, even it if should not be allowed to 



Introductory 19 

dominate the whole of life ; while it should be kept in its 
place, it should never be forgotten. 

Justification of Economics. — The advantage of isolating 
the economic aspects of society for separate study is that it 
conduces to clear thinking and a better understanding of the 
complexity of social relations. Its justification is the advance 
that has been made in the understanding of economic relations 
since Adam Smith made the study of them a separate science. 
In judicial procedure experience has taught the necessity of 
considering separately questions of fact and questions of law, 
although both are essential to the judgment ; similarly in 
social study, it is a help to consider questions of economic 
fact and questions of moral right separately, although our 
action will be influenced by the two considerations jointly. 
The separation assists in the constructive handling of the 
mass of facts which bewilder us at our first attempt to dis- 
cover the principles of the social organization. It prevents 
the confusion of thought and the argument at cross-purposes 
which inevitably result from the attempt to discuss all the 
aspects of a complicated question at once. Just as physiology, 
anatomy, and psychology study the saiiie subject, man, from 
different points of view, so the social sciences, economics, 
ethics, politics, and law, study different aspects of the same 
subject, society. The method is simply an appb'cation of the 
common-sense principle," One thing at a time." Specialization 
is as necessary in research as in industry ; the progress of 
knowledge has been based on the same principle as the growth 
of the Roman Empire, Divide et impera. The method has its 
dangers, since aspects of a problem that can be separated for 
study cannot be separated for purposes of action ; but the 
misuse of the conclusions of specialized study is no reason for 
giving up the study. 

The following pages will not answer all the questions that 
have been raised in this chapter ; considerations of space 
and the patience of readers forbid. What they attempt to 



20 Economics for the General Reader 

do is to provide the general reader with a framework into 
which he can fit the facts and principles which he acquires in 
the course of his own experience, to put at his service some of 
the conceptions and lines of thought which students have 
found useful, and to introduce him to a systematic study of 
the more important questions which are raised by any attempt 
to understand present-day economic arrangements as a whole. 



CHAPTER II 

THE DIVISION OF LABOR 

I 

The Economy of Specialization 

Division of Labor. — The clew to the labyrinth in which the 
attempt to analyze a simple business transaction involves the 
inquirer is given in the first sentence of Adam Smith's Wealth 
of Nations; " The greatest improvement in the productive 
powers of labor, and the greater part of the skill, dexterity, 
and judgment with which it is anywhere directed, or applied, 
seem to have been the effects of the division of labor." Others 
had seen that the division of labor was important; Adam 
Smith first gave it its true place as the fundamental principle 
of economic organization, and on that account perhaps put it 
at the very beginning of his treatise. The history of industry 
can be viewed as simply the ever widening application of the 
principle of the division of labor; the latest economy in 
business organization, the so-called " scientific management," 
is a conscious application of it. 

From the point of view of the individual the division of 
labor means specialization; from the point of view of society 
it means cooperation. The individual specializes, because by 
restricting his work to a single trade or a single process he can 
become more efiicient at his work than he could be if it were 
more varied. But speciaUzation by individuals is practicable 
only in society. Some individuals can give their time ex- 



22 Economics for the General Reader 

clusively to the provision of clothing or furniture, only because 
other individuals are directing their efforts to the provision of 
food and shelter. In an advanced industrial society every 
producer is a specialist in detail, because the society includes 
speciaUsts in every other kind of work needed to satisfy the 
society's wants. 

Advantages of Specialization. — Specialization is funda- 
mental in economic organization, because it is the means by 
which man increases the return to a given amount of work. It 
brings about this result in two ways, by subdivision of tasks 
and by repetition of tasks. Subdivision results in operations 
easier in themselves, repetition enables operations to be 
performed with greater ease. " Practice makes perfect " ; 
an operation, if repeated often enough, becomes a habit; 
our bodies and brains adjust themselves to performing per- 
fectly and without effort what at first is done only badly and 
with great effort. The estimation of forces and sizes, the 
exact coordination of hand and eye, called for by almost any 
craft, become instinctive by speciah'zation ; by practice is 
built up the specialized experience which is the explanation 
of achievement in all kinds of work — the craftsman's " sense " 
of the possibilities of his materials, the dealer's " instinct " 
for his market, the physician's " intuition " of disease, the 
connoisseur's " feeling " for quality in the objects of his 
study. Delicate tasks come to be performed with accuracy, 
the speed of work is increased, the strain involved in the 
performance of any single task is reduced; the routine of 
work is, in James's phrase, handed over " to the effortless 
custody of automatism." 

Division of Labor and Exchange. — Specialization can 
occur only in a society, and implies the habit of exchange. 
The direct exchange of goods for goods, and goods for services, 
is called barter, and is so clumsy a method of carrying on 
exchange that speciaUzation could never have gone far with- 
out some medium of exchange which would obviate the clum- 



r 



The Division of Labor 

siness of barter. Such a medium of exchange is M'one> 
Later we shall examine in some detail the qualities of/a good 
medium of exchange, and the way in which money does its 
work. Here we need to notice only that such a medium of 
exchange, generally accepted and easily divisible, is necessary 
to enable individuals to speciah'ze. So long as money was 
scarce in quantity and uncertain in quaHty, so long, that 
is, as exchanges had to take the form of barter, there was 
little specialization. The great mass of people were agri- 
culturists raising their own living ; there were few speciaUzed 
workers ; trade was confined to luxuries and the small surplus 
of production over immediate local needs ; few people got 
more than bare physical necessities, and not even these with 
certainty. In the England of Elizabeth, in continental 
Europe until much later, as in Asia to-day, the great bulk of 
the population consisted of peasants engaged in subsistence 
husbandry. Even then, however, specialization was the 
chief means of increasing wealth ; Adam Smith wrote before 
the Industrial Revolution. 

Forms of Division of Labor. — The simplest form of the 
division of labor is the speciah'zation of individuals to single 
industries or trades. As soon as there was any surplus of 
produce over immediate local needs, the specialized trader 
arose to collect and distribute that surplus. A very small 
village community was large enough to enable individuals to 
devote themselves exclusively to the work of the smith and 
corn-miller. The making of cloth, baking, the working of 
stone and leather differentiate themselves early ; in a modern 
community the jobbing carpenter and tailor, the doctor and 
lawyer, the artist and priest represent this type of the 
division of labor. 

The next form of the division of labor, historically and 
logically, is the subdivision of one specialized craft into 
separate processes and the specialization of " detail " workers 
to each of these processes. Just as the working of metal will 



24 Economics for the General Reader 

be done better by a specialized smith than by a comparatively 
unspeciaUzed worker like a farmer, so the manufacture of 
any common metal object will be more rapid and efficient, 
if it is split up into several processes and a speciaUzed worker 
set on each of these processes as his exclusive work. Thus 
the making of cloth became the work of spinners, weavers, 
fullers, dyers, finishers, each of whom worked at a single 
process with specialized tools. The cutlery trade to-day is 
still largely in this condition. The forging, grinding, and 
putting together of the different parts are each the work of 
a speciaUzed workman, though the " cutler," who puts to- 
gether, performs not one but thirty or forty operations. Such 
subdivision of processes, in addition to increasing the efficiency 
of the worker at the speciaHzed task, leads to improvements in 
tools, and ultimately to the invention and application of 
machinery. A trade in which the making of the article is 
the work of a number of workers, each specialized to a single 
process, is, in Marx's words, " a productive mechanism the 
parts of which are human beings." 

II 

Machinery 

Machinery the Result of Division of Labor. — "A pro- 
ductive mechanism the parts of which are human beings " 
tends inevitably to give way to a productive mechanism the 
parts of which shall be inanimate machines. The use of 
machinery is a result of the division of labor. Once the 
processes of any manufacture have been split up into opera- 
tions so simple that they can be called " mechanical," the 
manufacture is ready to be taken over by a machine. A 
machine is more reliable and efficient than the most accurate 
of human workers ; a human being, however restricted in 
the scope of his activities, is not a machine, he is liable to 



The Division oj Labor 25 

fatigue and inattention, and cannot give the unceasing 
regularity and uniformity of a steel tool mechanically 
actuated. The handing over of a process to machinery may 
be delayed by the existence of cheap labor, but ultimately 
the machine is bound to win. 

The application of machinery to industry, itself the out- 
come of division of labor, leads to the further specialization of 
human workers. A machine is a specialized tool which 
cannot be taught to do anything for which it was not originally 
intended ; it is confined to a single process or to a narrow 
range of processes, and the human worker who tends it 
becomes just as specialized himself. We get, therefore, a 
new series of crafts, arising from the need of special skill to 
tend special machines. This is not, however, a permanent 
condition of things ; so far as the increasing perfection of 
machinery makes special human skill unnecessary, it tends 
to have the opposite effect on the worker ; so far as the machine 
takes over all the specialized work, it tends to make the worker 
an unspecialized tender of machines in general. The increasing 
use of automatic machine-tools, for instance in some branches 
of the machine industry, tends to make unnecessary the 
specialized skill of turner, driller, planer, slotter, etc., and to 
require only the general skill of the man who " sets up " a 
machine. 

Machinery Promotes Division of Labor. — In other and 
more important ways the application of machinery to industry 
promotes the division of labor. It makes the process of any 
manufacture more " roundabout " than it was before. The 
use of machinery requires the specialization of a certain pro- 
portion of the workers engaged in an industry to the making 
of the machines. That in its turn requires the specialization 
of other workers to the making of tools for making machines, 
and to the extraction and working of iron and the other raw 
materials from which these are made. The manufacture of 
cloth, for instance, no longer employs only the shepherd and 



26 Economics for the General Reader 

shearer, the spinner, weaver, and finisher; it requires also, 
as we have seen, many classes of machinists to make the 
carding, combing, and spinning machinery, the looms, etc. 
It requires also the specialization of more workers to make 
the power-plant, to feed it and tend it. It creates in fact 
the great trades of machine-making, coal and iron mining, 
etc., which lie at the foundation of all big manufactures to-day. 
Hence the social cooperation which results from the speciali- 
zation of individuals has become infinitely more complex and 
far-reaching. 

Power Machinery the Basis of the Industrial Revolution. — 
Non-human power, such as steam, is of use in industry when 
the final processes of manufacture are still dependent on 
the speciaHzed skill of manual workers ; it becomes infinitely 
more important when these processes are executed by 
machines. The machine requires room to house it and power 
to drive it, and one room and one power-plant will serve 
many machines. The application of power to industry 
leads to the collection of many machines in one building 
and the employment of human workers in regiments. The 
use of machinery is limited in its scope without non-human 
power; and on the other hand, the construction of large 
power-plants is possible only by the use of machinery. Once 
power and machinery have been invented, the scope of 
industry is enormously widened. The specialized worker 
ceases to manufacture directly; he tends and controls 
machines and engines which manufacture for him. Labor, 
whether it becomes more or less specialized, becomes in- 
creasingly cooperative in character ; in Marx's words, " the 
cooperative character of the labor process is ... a technical 
necessity dictated by the instrument of labor itself." 

And this new cooperation of machine-makers with other 
workers, of non-human power with human labor, makes 
enterprises possible which were inconceivable so long as 
human workers had not specialized some of their labor to 



The Division of Labor 27 

producing this power. No collection of human beings could 
exert directly the concentrated force of a steam-hammer ; 
you could not, as Professor Meredith remarks, have a railway 
on a domestic system. Power increases the speed and output 
of machinery and labor to such an extent that the individual 
worker cannot maintain himself in industry without its aid. 
The relation of man to machine is reversed ; before the appli- 
cation of power the former is principal and the latter assistant, 
after the application of power the machine is principal and 
the man assistant. The ownership of the instruments of 
production becomes vastly more important, and production 
by individuals and little groups gives place to production by 
regiments of workers in factories. The application of non- 
human power to machinery, then, is the revolution in any 
industry, and the simultaneous appHcation to several im- 
portant industries is the Industrial Revolution. 

Ill 

The Localization of Industries 

The Basis of Localization. — Following our clew specializa- 
tion, we shall understand another feature of modern industry, 
the concentration of industries in particular localities. In 
modern industry labor and machines are specialized wherever 
there is a sufficient volume of trade to keep a specialist con- 
stantly at work ; the main processes in the manufacture of the 
chief products of industry are all of them carried on by 
specialized machines tended by speciahzed labor. Now the 
simplest way for a firm to make sure that there will be suffi- 
cient volume of trade to enable it to adopt these methods of 
specialization is to establish its works in a district where 
there are other firms engaged in the same trade. 

The influences which have brought a particular industry 
to a particular district can be discovered only by studying its 



28 Economics for the General Reader 

history. But three influences are usually predominant. 
First, cheap power, in the form of coal or water ; and this is 
the most important to-day. The great industrial centers of 
the world are its coal-fields. Any technical invention which 
offered a cheaper source of power than coal — such, for 
example, as the use of the tides — would tend to rearrange the 
distribution of industry ; in another century industry may be 
concentrated on the ocean front and along inland streams, 
while people go for quiet and recuperation to Pittsburg and 
to Gary. Cheap labor has an attraction for industry similar 
to cheap power; the industries in the crowded sections of 
many American cities are often based on the cheap labor of 
the wives and children of foreign immigrants. The second 
great influence is accessibihty to raw materials. The manu- 
facture of steel is strongly localized on those coal-fields 
which have ore-deposits adjacent, or, in a town like Gary, 
Ind., at the most convenient point between the coal-fields 
and the iron mines. The flour-milling industry, which was 
formerly distributed as widely as the growing of grain, tends 
now to be concentrated near the great grain-distributing 
centers. The third great influence is accessibility to markets. 
The last two influences were much more important before the 
Industrial Revolution than they are now that transport has 
become so cheap ; the importance of the first dates, of course, 
from the Industrial Revolution. 

Advantages of Localization. — Whatever the influences, 
however, which bring an industry to a district, the chief 
advantages of localized industry are all due to the opportunities 
for greater speciaHzation which concentration affords. Where 
many firms engaged in the same industry are grouped together, 
the worker has a better market for his specialized skill and is 
encouraged to specialize still further. The employer has less 
difficulty in finding the kind of labor he wants. The industry 
can command a large number of special services which no 
single firm could afford and no scattered industry could 



The Division of Labor 29 

maintain. Among the most important of such services is 
the specialized market. The New England mill towns provide 
the cotton-spinner and manufacturer with facihties for getting 
their raw materials and disposing of their finished products 
which they could find only with difiiculty elsewhere, and these 
facihties can be supplied because the cotton industry is so 
strongly localized. Special transport facihties and the 
provision of commercial intelhgence can be arranged for a 
locahzed industry. Scientists, lawyers, accountants find it 
worth their while to speciaUze in the problems pecuhar to 
the local industry. Insurance can be effected cheaper. 
Probably the use of credit can be obtained cheaper where 
risks and conditions are so well known as they are in a modern 
specialized locality. 

Localization and Allied Trades. — An important type of 
specialized services is the growth of subsidiary industries, 
supplying the staple industry with its machinery and incidental 
requirements of manufacture, and utihzing its by-products. 
The making of machinery is less locahzed than other great 
industries, because the requirements of a modern locahzed 
industry are so special that they can best be met by a firm on 
the spot. The textile districts are the seat also of the dyeing 
and finishing trades, speciahzed to suit the particular material 
manufactured in the district ; and these in their turn attract 
certain chemical and drysalting trades. The complete 
utiHzation of by-products is one of the most important 
economies of modern industry, and is possible only where a 
localized industry makes a large bulk available without 
transport charges. Science can find an industrial use for 
most things, provided that they can be had in quantities and 
cheap. 

BusLness Organization and Specialization. — While the 
tendency to specialization is universal in the great industries, 
the relation of the specialized process to the firm or business 
unit varies. The speciaUzation may take place within the 



30 Economics for the General Reader 

firm or within the trade ; i.e. processes may be carried out by 
specialized departments in the firm, or by specialized firms in 
the trade. During the greater part of the nineteenth century 
the tendency was for individual firms to devote themselves 
more and more exclusively to a single process or a small group 
of related processes. To-day in many trades the tendency is 
in the opposite direction, namely, to unify under one manage- 
ment all the processes in the manufacture of a given product. 
The opposing tendencies may be seen most clearly by con- 
trasting the heavy steel industry with the leading textile 
industries. In the former, till the middle of the nineteenth 
century, the different processes of the manufacture of steel, 
the getting and blasting of the ore, the working of the steel, 
and the construction of ships, bridges, and other heavy steel 
goods, were carried on chiefly by separate firms. To-day the 
rule is for all processes to be carried on by the same manage- 
ment. In the woolen industry, on the other hand, the 
different processes, combing, spinning, weaving, dyeing, and 
finishing, are usually undertaken by separate firms ; many 
firms deal with one special kind of wool or yarn only, and 
it is the rare exception for a single firm to carry the wool 
through all the processes of manufacture. The specialization 
of labor and processes is just as detailed in the heavy steel 
industry as in the textile industries, but the business unit 
is different. To some extent the difference is due to techni- 
cal economies ; in the steel industry, where the whole 
manufacture is under one management, the steel can be 
passed forward from process to process without reheating. 
Another reason may be the difference in the size of a unit of 
product. In the heavy steel industry the unit is immense — ■ 
a bridge or an ocean liner — and the contributing processes 
of manufacture are very numerous and varied ; hence cen- 
tralized management is an economy. In the textile trades 
the unit of product is small — the piece — the processes of 
manufacture comparatively few and simple, and success in 



The Division of Labor 31 

management dependent chiefly on securing a large and steady 
output of uniform quality. 

IV 

Large-scale Production^ and the Limits of Specialization 

Specialization and Concentration. — An important result 
of the specialization of labor and the use of power-machines 
has been the growth of large-scale enterprise. How far does 
this tendency go? The terms large-scale and small-scale 
enterprise are obviously relative to the industry, and the 
chief influence in fixing the average size of the business is the 
technical methods of the trade. Small-scale coal-mining is 
still carried on, but it is unimportant ; while steel shipbuilding 
can be carried on only by a large concern. Certain general 
aspects of organization, however, can be considered without 
immediate reference to technical considerations. 

Advantages of Concentration. — On the whole, there is a 
steady tendency towards enterprise on a large scale. The 
advantages of large-scale enterprise are very Uke the advan- 
tages of localization of industry, since they consist chiefly 
in the greater speciaUzation of implements and workers 
which a large output permits. A large works can employ 
highly speciaHzed workers of all grades, and keep them fully 
employed on their special work ; it can buy the best skill, 
and get good value for a good wage, while a small firm that 
employs a highly specialized worker will have to use him 
part of his time for other purposes, for which a less paid 
worker would have done as well. The large firm can do the 
same with machines ; it can build an automatic machine for 
a single detail of a single process, because its large output 
insures that this detail will recur so frequently as to keep the 
machine constantly at work. It can afford resources which a 
small firm has not enough work to make worth while. A big 
machine shop with its electric crane will move a casting in a 



32 Economics for the General Reader 

tenth of the time taken in a small shop without that con- 
venience. A big works can have its own railway-sidings and 
wharves, its repair shops to save time and prevent dislocation in 
case of a breakdown. A Rockefeller dealing with oil in bulk 
could construct a system of pipe-lines for distributing it 
which was very expensive, but, once it was constructed, far 
more economical than any other means. The big concern 
can save sometimes by buying its material in bulk. It should 
always save in its selling organization by employing fewer 
travelers and advertising less : its goods advertise one 
another. 

Weaknesses of Concentration. — The advantages of large- 
scale production are so great that we might expect the small 
firm to be driven out of industry. But the small firm refuses 
to be driven out ; if the reader doubts this, let him consult a 
local trade directory and count the number of small businesses 
in it. The small firm has advantages of its own to set against 
the obvious economies of a large output. We must remember 
that small and large firms are usually competing for a growing 
volume of trade, not for a fixed amount ; so that the gains of 
the large concern need not necessarily be at the expense of 
the small concern. But there are other reasons, especially 
the difl&culties connected with the organization of a big works. 
With every increase in the size of a concern, there is a more 
than proportionate increase in the difficulty of management 
and organization. " Just as in an army there are many who 
can fill the position of captain, few who can fill that of colonel, 
and almost none who are competent to be generals in com- 
mand — so in industrial enterprise there are many men who 
can manage a thousand dollars, few who can manage a million, 
and next to none who can manage fifty millions." ^ Hence 
there is usually more waste in the big than in the small con- 
cern ; especially is this the case when the firms contrasted are 
a large joint-stock company managed by salaried officials 
^ A. T. Hadley, quoted by Macgregor, Industrial Combination, p. 37. 



The Division of Labor 33 

and a small private business managed by the owner, who bears 
any loss due to waste. 

A particular form of waste and a weakness of all big con- 
cerns is the tendency to routine. The detailed specialization, 
the need for checks and records, involve routine — the routine 
we call " red tape " in the case of Government Departments 
— and routine kills initiative and adaptabihty. The big 
concern can usually produce only standard Unes. It cannot 
adapt its organization so quickly as the smaller firms to 
the changing wants and whims of the customer. It can 
give the customer the kind of thing he wants much more 
cheaply than the small firm; it can seldom give him exactly 
the thing he wants, and the customer will often pay out of all 
proportion for the slight additional satisfaction of getting the 
exact thing. 

Obstacles to Concentration. — In some important industries 
there are technical obstacles to large-scale enterprise. 
Wherever the material worked is not uniform in quality, 
or cannot be graded and treated in bulk, then the large- 
scale method of specialized processes and large output will 
not apply. In agriculture the opposition appears clearly. 
Where population is sparse and land is cheap, grain farming 
with agricultural machinery or stock raising on a large 
scale is economical. In more crowded regions it pays better 
to utilize the slightly varying qualities of every acre — by 
fruit, vegetable, or dairy farming — and the necessary care 
and detailed attention will be best given by the small farmer, 
especially the small proprietor. 

Again, specialization within the trade puts within the 
reach of the small firm facilities which, but for the localization 
of industries, would be within the reach of large firms only. 
The full utilization of by-products, the adaptation of means 
of transport to the needs of the staple trade, insurance and 
credit agencies, special markets, the services of experts and 
subsidiary industries, all help the average-sized concern to 



34 Economics for the General Reader 

hold its own in the market against the giant concern. The 
development of large-scale production in a subsidiary industry 
or a section of an industry may be a help to small-scale enter- 
prise in another part of the industry; the small joiner can 
get moldings from the large sawmill, the small cycle-builder 
parts from the factory which makes parts. In every trade, 
however, there seems to be a point beyond which any in- 
crease in the size of the concern brings no new economies, or 
rather beyond which any new economies are neutralized by 
the increased difficulty in the work of management. This 
limit is constantly receding as the work of management is 
reduced to routine or science ; but the limit is always there 
in the limited capacity of the average business man. And 
such statistics as are available, especially those of the United 
States,^ where the tendency to concentration is strongest, 
show that the number of separate businesses is increasing 
more rapidly than the population. 

Specialization and the Extent of the Market. — The small 
firm holds its own; the average size of firms increases, but 
the number of firms also increases. The advantage of the big 
firm is that it can carry speciahzation further ; the strength of 
the small firm lies in the limits of speciahzation. How far can 
speciahzation be carried? We may go again to Adam Smith 
for our answer : " The division of labor is limited by the extent 
of the market." Unless there is a large market, which imphes 
a large, steady, and uniform demand, specialization does not 
pay. It does not pay to specialize a man or a machine, unless 
there is sufi&cient work to keep them constantly employed on 
their special work. Speciahzation is most economical when 

^ Number of factories, excluding hand and neighborhood industries : — 

1899 (recorded in 1900 Census) . . 207,514 

1904 ( " " 190S " ) . . 216,180 

1909 ( " " igio " ) . . 268,491 

Including hand and neighborhood industries : — 

1889 (recorded in 1890 Census) . . 355,405 

1899 ( " " 1900 " ) . . 512,191 



The Division of Labor 35 

applied to a manufacture that can be standardized, and an 
article or process cannot be standardized unless there is a 
large trade. 

The Survival of the Small Firm. — Now there are many 
articles and services for which the demand is not large, 
steady, and uniform ; there are many processes of manu- 
facture which cannot be standardized. Here is the field 
of the small firm. When a single specialized craftsman per- 
formed all the processes of a manufacture, he not infre- 
quently, as a part of his craft, made and repaired his 
own tools. The " tools " of modern industry are machines, 
and the making of them is a specialized industry with many 
branches ; the repairs, however, of modern industry cannot 
be so specialized. Consequently, there are many small 
businesses which are occupied wholly in repairs ; and though 
the system of constructing all machines of interchangeable 
parts makes the work of many of them unnecessary, there 
must always be a need for some " general " artisans and busi- 
nesses capable of dealing with any repair. Similarly, the 
advantages of being on the spot and not too specialized will 
probably enable the single workman to keep a large share of 
the work of domestic repairs and retail shopkeeping. 

Technical difficulties in the way of standardizing processes 
still offer obstacles to large-scale production, as in all kinds of 
intensive agriculture. Cutlery and other light metal trades, 
though using more and more machinery, will long retain a 
place for the " Httle master." Thirty-eight separate opera- 
tions are needed to put together the parts of a cheap pocket- 
knife, and such work does not offer much scope to the auto- 
matic machine. So far as power is needed, there was a force 
driving the " little master " into the factory ; but that force 
works now rather in the opposite direction, for the little master 
can obtain a supply of power in his own workshop by employ- 
ing electricity. When an industry is new and its methods and 
processes are still experimental, the adaptabihty of the small 



36 Economics for the General Reader 

finn is a greater advantage than the resources of the large 
firm, and the small firm usually plays the part of pioneer. 
The biggest firms, in industries in which large and small 
firms are both found, are often firms which began in a small 
way and seized their chance when the industry was new, or 
when some invention or new market gave the industry a new 
start. 

In some industries, though the processes could be stand- 
ardized, the demand for an article is so limited that it would 
be absurd and wasteful to employ the resources of modern 
machinery and industrial organization. The weaving of 
short patterns and ranges in the textile trades is largely done 
on hand-looms for this reason, and certain expensive Paris 
fabrics, where the order for a pattern may not exceed a dozen 
yards, are still manufactured by " httle master" weavers 
working for merchants. These workers are in the same 
economic position — though they possess a much higher 
economic and social status — as many of the " sweated " 
workers. Among " sweated " workers the division of pro- 
cesses has usually been carried far enough to make the work 
of each individual simple and easy, but the natural evolution 
from that simplified manual work to the use of power-machines 
has not taken place because the labor can be got cheaper 
than the machine. Hence the domestic hand-workers in 
such trades as the tailoring, shirt-making, and box-making 
trades are competing with power-machines in the factory 
trades and can sustain the competition only by accepting 
wages too low to " keep " them in any real sense. 

Wherever individual requirements have to be met, the 
factory-made article is out of place. Clothes and shoes are 
made in factories ; but if we want clothes or shoes that fit 
exactly, and not merely approximately, we go to the custom 
tailor or boot-maker, who does not carry specialization far. 
Individuality is the essence of art ; to be beautiful it would 
seem that a thing must bear the impress of its maker's per- 



The Division of Labor 37 

sonality. There is little room then for specialization in the 
making of beautiful things. If we want the material 
apparatus of life to be beautiful, we must be content with 
less of it ; we must choose between a great many ugly and 
ordinary things and a few beautiful and unique things. 

The State of the Market and Transport. — Adam Smith's 
principle " that the division of labor is limited by the extent 
of the market," is illuminating in another respect. The most 
important influence in determining the extent of the market 
is the state of the means of transport. Every improvement 
in the means of transport makes exchanges economical which 
before were not economical. It enables the district which can 
produce an article cheapest to supply other districts more 
cheaply than they can make for themselves, that is, to 
extend its market ; therefore, Adam Smith says, " good 
roads, canals, and navigable rivers, by diminishing the 
expense of carriage . . . are . . . the greatest of all im- 
provements." Cheap transport encourages the full utilization 
of special local advantages such as climate, soil, traditional 
skill, estabhshed organization ; the production of goods where 
they can be produced cheapest ; the progressive localization 
of industries ; and the use of the resources of each district 
for the benefit of all districts. Trade began in luxuries; 
with improvements in roads and the art of navigation, 
it extended to comforts; in the nineteenth century, with 
the application of steam-power to transport, it extended to 
the necessities of life. Transport is now so cheap that in 
advanced industrial countries districts are like individuals, 
specialized in production and dependent on exchange for 
the satisfaction of their most important wants. Because the 
localization of industries, with all its economies in produc- 
tion, is dependent on cheap and efficient transport, the trans- 
port industries are, with the steel and coal industries and the 
credit system, at the foundation of the modern industrial 
organization. 



38 Economics for the General Reader 



The Evils of Specialization 

Narrowness. — The benefits of the division of labor He in 
the increased power it gives man to produce wealth of all 
kinds. This increase is incalculable ; without it life would be 
like the Hfe of Hobbes's primitive man, " solitary, poore, 
nasty, brutish and short." If any reader doubts the benefits, 
let him make a list of the things he uses and consumes in the 
course of a single day, and then estimate the time it would 
take him to produce these by his own unaided labor ; such 
an experiment will do more than any amount of reading to 
convince him. But these benefits are accompanied for 
the worker by serious evils, and the benefits have rather 
obscured the evils and prevented due efforts to remove 
them. One reason for this neglect may be that modern 
industrial methods have incidentally counteracted some of 
these evils. The great improvement in the material con- 
ditions of the worker's Hfe, which has resulted from the 
greater productivity of modern industry, has given the 
industrial worker opportunities of self-culture which have 
neutralized some of the evils of specialization. He is better 
clothed, better fed, better housed, and he lives a fuller Hfe 
outside his work than he did in the days when the work 
itself was less narrowly speciaHzed and more educational. 
Similarly, the concentration of the industrial population in 
towns, in spite of its pecuHar evils, has stimulated intellectual 
Hfe and, with increased leisure and income, done much to 
counteract the deadening effects of monotonous employment. 
The New England cotton operative is occupied with a far 
narrower range of operations than the farm laborer ; his ma- 
terial environment is far less varied, and his work far less 
interesting, yet his intellectual Hfe is far more vigorous; 
the general intellectual keenness of some of the mill towns 
might put some universities to shame. 



The Division of Labor 39 

Means Substituted for End. — But the advantages, di- 
rect and indirect, of the division of labor are no reason for 
ignoring the evils, if any consideration of these will tend to 
reduce them. We shall refer to them again in Chapter 
XXIV, but some consideration of them will not be wasted 
here, since we shall have to refer to the division of labor again 
and again in the intervening chapters. The first of these 
evils is the inevitable danger that the workman will be treated 
simply as a means and not as an end. Dr. Ure, and other 
early advocates of the Factory System, did habitually write as 
if man was intended for production, not production for man ; 
they justify Marx's statement : " In its machinery system 
Modern Industry has a productive organism that is purely 
objective, in which the laborer becomes a mere appendage to 
an already existing material condition of production." The 
earlier English factory owners were guilty of the systematic 
exploitation of child-labor. Machines were adapted, and the 
processes of manual labor simplified, to suit the children's 
powers, and their labor was used with entire disregard to their 
subsequent life. The half-timer of to-day, the doffers in the 
worsted factory who acquire a skill worth a few dollars a 
week and learn nothing more, the cotton-piecers who by no 
possibility can all of them become spinners ; the youths who 
work light automatics in machine shops and earn a good wage 
for a youth, without having the chance of fitting themselves 
for earning a good wage for a man ; the whole crowd of " Blind 
Alley " occupations which the English Poor Law Commission 
in 1909, and Karl Marx in 1867, showed to be an integral part 
of the modern industrial system, are only the most striking 
example of this use of human beings as " means " of pro- 
duction without reference to their right to consideration as 
" ends." The latter instance has attracted attention because 
the industrial use of children and adolescents often makes 
them industrially useless when they become adults. But the 
detailed specialization of laborers must always hamper the 



4© Economics for the General Reader 

all-round development of the faculties, which was the Pagan 
ideal of manhood and is not inconsistent with the Christian 
ideal. Specialization of labor and monotony of work make 
for economic efficiency, but are not therefore wholly good ; 
by themselves they tend to produce lop-sided development 
in the man ; and the social system which accepts the increase 
of wealth due to the monotony of work, without devoting 
some of it to counteracting the effects of that monotony out- 
side work, is forgetting the end for which wealth is produced. 
Evil Partially Hidden. — This tendency of the division of 
labor to degrade or hamper the development of large masses 
of workers is not noticed, because the increased wealth due 
to it neutraUzes many of its ill effects. But the tendency is 
there, and, if anything, is increasing in strength. The actual 
processes in which the detail laborers are engaged are perhaps 
calhng for a higher t5^e of machine-tender, and the ex- 
ploitation of child labor is diminishing ; but the manual la- 
borer is getting less if anything of the organizing work in 
industry, the work of direction, which requires initiative and 
develops character. The specialization of the work of direc- 
tion, of organization, of initiative in the hands of a small 
proportion of the whole number of people " engaged " in 
industry, is perhaps the greatest evil of the modern industrial 
organization. It removes from the work of the great majority 
of people the educational element, the element that develops 
the highest faculties and character. The medieval crafts- 
man, Uke the working farmer to-day, was constantly making 
choice between alternatives and exercising his judgment and 
initiative; and exercise develops will and judgment. Not 
only were the processes of manufacture not reduced to routine, 
but each man had the conduct of the business side of his 
work himself. He was his own master, self-controlled ; he 
dealt directly with the market, and though the market was a 
little local market, a simple thing compared with the mar- 
ket of to-day, it did take a man outside his workshop and 



The Division oj Labor 41 

gave him some practice in the difficult art of adjusting social 
relations. 

Destruction of Initiative. — The great mass of workers 
to-day are not self-controlled ; they are cogs in a machine 
controlled by others, and their efficiency depends less on their 
initiative and adaptability than on mechanical regularity of 
work. They have no part in the organization of the work- 
shop ; they have no part in the organization of trades which is 
done in the market. Their work is routine — requiring often 
a very high degree of specialized skill, but still routine ; and 
routine is not educational. It kills initiative and stupefies 
character. The grading of work, the possibility of keeping 
your ablest men constantly occupied on the most difficult 
work, which is always pointed out as one of the chief economies 
of the division of labor, tends to be realized. The great 
organizer has concentrated in his charge all the work of 
organization and direction which an industrial unit, including 
hundreds of workers, requires ; and if he has the work the 
others cannot have it. He does it far better than smaller 
men would do it ; but the fact that he does it and they do not 
makes him bigger still and them smaller still. What orig- 
inality they are capable of is never developed, while his 
organizing faculties are developed to their highest pitch. The 
work of organization, direction, initiative, tends to be 
specialized, like any process of material manufacture. The 
economic result is more efl&cient organization and direction, 
and an increasing rate of technical progress ; the social result 
is that the mass of adults have their chief educational element 
taken out of their work; and since their work occupies the 
greater part of their working lives, and has the first claim on 
their faculties, the loss is irreparable. 

Probably this concentration of responsible work in the 
hands of a small class, the great majority of workers being 
specialized to automatic, non-responsible work, is the chief 
explanation of the most remarkable social phenomenon of 



42 Economics for the General Reader 

the time. In some Western countries with democratic 
franchises one-tenth of the people own nine-tenths of the 
wealth. A considerable proportion of the voters are con- 
stantly on the verge of destitution, while a small minority 
flaunt in their faces the most extravagant luxury. How is 
it that the populace does not use its political power to remove 
such inequaUties ? What is it prevents the social revolution ? 
It is not a scientific understanding of the reasons of these 
inequalities, or any doubt as to the possibilities of reorganizing 
industry without them, for no study is so neglected in Eng- 
land and the United States as the scientific study of economic 
organization. The explanation is largely habit, the inertia 
of uneducated masses, the fatalism that is almost inevitable 
after ten hours a day, five and a half days a week, and fifty 
weeks a year of monotonous toil in a factory. But another 
explanation is that the people who suffer most under the 
present industrial system have the habit of initiative rigorously 
ground out of them by the system. If they have ideas of 
something better they have no experience of putting ideas 
into effect. They are revolutionary and Utopian when what 
is wanted is the practical experience of the business man. 
They are so in the habit of being told what to do that they do 
nothing when they have only themselves to tell them to do it. 
Of course there are individuals who retain their initiative and 
capacity for direction in spite of the mechanical nature of 
their work, but they — even if their capacity does not lift 
them out of their class — are helpless so long as the mass of 
their fellows succumb to the mechanical nature of their work. 
In Marx's words, " the separation of the intellectual powers of 
production from the manual labor, and the conversion of these 
powers into the might of capital over labor, is . . . finally 
completed by modern industry erected on the foundation of 
machinery." 

Risk of Specialization. — The individual laborer suffers 
in another way. By being forced to specialize, he is forced 



The Division of Labor 43 

to incur the risks of specialization. The highly specialized 
workman is in the same position as the capitalist who has 
invested his capital in highly specialized machinery. His 
skill has only a limited field of employment, and loses its 
value outside that field. Hence he may be forced to accept 
terms which are below the market price for that standard of 
energy and knowledge, the only alternative being to give up his 
special skill and seek employment in another trade. The 
fact that there was a dearth of coal-miners would not assist 
the artisan in an overcrowded trade to protect his standard 
of life. Further, the artisan with a highly specialized skill 
has a commodity to sell which may have a monopoly value 
one year and have lost its value the next owing to some 
invention. The owner of machinery provides against a 
similar event by writing off so much of the value of his 
machinery annually ; the owner of skill should perhaps do 
the same, but the wages are rarely big enough to encourage 
such rigorous account-keeping; and the possibility which 
technical science continually offers the employer of dis- 
pensing with certain classes of skill by introducing new 
processes seriously weakens the bargaining position of the 
workman, and increases his dependence on the employer. 
The egregious Dr. Ure's description of the self-acting mule, 
" a creation destined to restore order among the industrious 
classes," and the inference he draws, " when capital enlists 
science into her service, the refractory hand of labor will 
always be taught docility," are very significant. 

Lack of Adaptability and Production. — The extreme spe- 
cialization of modern industry is not without its disadvantages 
from the point of view of productivity. While it increases the 
efficiency of the laborer for particular tasks, it limits his scope, 
lessening his adaptability and capacity for undertaking novel 
work. And the technique of industry changes rapidly. " We 
do not to-day want men who are ' all round ' at building 
marine-engines — we do need men who are * all round ' 



44 Economics for the General Reader 

mechanical engineers — men who can apply the principles of 
their craft to any form of machinery that may be called for," 
Sir Christopher Furniss told the British Poor Law Commission. 
" If [the boy's] training is sacrificed to the demand for a 
very limited and highly specialized skill in the management 
of one kind of machine or in one operation, the factory may 
benefit at the moment, but will suffer later on in having too 
few thoroughly trained men to draw upon when conditions 
change, as they must do in any progressive industry " (Pro- 
fessor Barr). Employers in the machine industry who com- 
plain that they cannot get men capable of anything but a 
single job have themselves to blame. The specialization of 
labor that pays the individual employer may be an economy 
in production for which society has to pay in the long run. 
The rate at which technique improves is limited by the 
capacity of labor to work the new methods. 

This raises the question whether the use of machinery may 
not make special skill unnecessary and ultimately restrict the 
division of labor. No generalization is possible. Machinery 
has undoubtedly superseded and is superseding "craftsman- 
ship " in all staple manufactures. That is the first effect 
of mechanical invention; the machine takes over the work 
formerly performed by the specialized manual skill of the 
laborer and makes the laborer a machine-feeder. But there 
is another effect. When the machine-feeder's work is purely 
mechanical the machine can also take that over; and the 
laborer's work, instead of being the mechanical " feeding," 
becomes the more complicated task of " setting up " the 
machine. Where women and young persons are employed 
power machinery has reduced the demand for skill; but in 
the greater industries employing adult male labor, while a 
lower grade of manual skill is required, a higher level of general 
intelligence is required. Machines become more intricate and 
delicate, and alter more rapidly ; their charge cannot be in- 
trusted to men who have not both manual dexterity of a 



The Division of Labor 45 

varied kind and an intelligent comprehension of the principle 
of the machine. Progressive employers who are constantly 
experimenting with new processes and methods may take 
trouble to train versatile and intelligent workmen. But a 
large output can usually be secured on conservative lines by 
the extreme specialization of labor; and that specialization 
makes against versatility and intelligence. To secure the 
plentiful supply of versatile and intelligent workmen that is 
essential if teclmical progress is not to be hampered, a system 
of technical education is needed for the rank and file as well as 
for the future leaders of industry which shall not be mere 
instruction in trades, but a liberal education in the sciences 
underlying technology, and this the best technical schools 
are trying to give. 



CHAPTER III 

THE ORGANIZATION OF PRODUCTION 

I 

The Coordination of Specialists 

The Necessity for Coordination, — We have seen that 
specialization is the principle on which the whole modern 
organization of industry is based ; let us see where it has led 
us. The man who wants a shirt no longer makes cloth and 
from the cloth makes a shirt. He buys the shirt, and the 
shirt is made by the combined labor of some hundreds of 
speciaHzed workers scattered all over the world. Every 
worker who takes part in the making of the shirt is 
specialized ; by himself he can do little or nothing, his labor 
is useful only when combined with the labor of other men 
equally specialized and therefore by themselves equally use- 
less. Every machine that is used is of service only because it 
is cooperating with the right kind of labor and with other 
machines. Every firm is specialized ; it makes nothing by 
itself, merely contributing its part to the whole process of 
making the shirt. What is called in ordinary conversation 
" the manufacture of shirts " is only the completion of a long 
process which began when the sheep was sheared that supplied 
the wool, or shall we say when the sheep was bred? Every 
industry is specialized, and many industries contribute to the 
making of one shirt; it is only by the cooperation of the 
sheep-farming, spinning, weaving, finishing, clothing, ma- 
chinery, coal, transport, and many other trades that the 

46 



The Organization of Production 47 

modern shirt manages to get itself made. Thus specialization 
has brought us to a condition in which laborers are helpless 
by themselves, machines are useless by themselves, firms 
make only a fraction of an article, and industries can do their 
work only by cooperating with other industries. How is all 
this cooperation brought about ? How are all the specialists 
linked up into an organization that can turn out shirts at 
$ 2.50 each? 

Coordination an Unconscious Process. — The specialists 
themselves are seldom conscious of this cooperation ; they 
do not do their work because others are dependent on it, but 
because they are paid to do it. Their combination is at first 
sight not the combination of a good football team, but the 
combination of a mob, or of the separate particles of water 
that combine under the compulsion of external force to form a 
stream. Nor is this cooperation organized by any central 
authority. Such an arrangement might have been possible 
in a City-State or an isolated kingdom, and the State at some 
periods in the past has attempted to control the direction of 
productive effort. But even in the time of the Gilds and 
under the Mercantile System, the movements and orgam'zation 
of industry were the result of spontaneous arrangements 
between individuals, regulated perhaps, but not dictated by 
the State. And to-day the industry of different countries is 
so intimately bound together in world-markets that there is 
no central authority far-reaching enough in its scope to under- 
take the direction and control of such extensive cooperation. 

Coordination Itself a Specialty. — How then is this co- 
operation secured? It is secured by a further appUcation of 
the principle of specialization itself, by the existence of a class 
whose work it is to organize this cooperation. Side by side 
with the growth of specialization in the processes of production, 
there has grown up a class of men whose business it is to link 
these specialists together and to make a working organization 
of them. These organizers of modem industry correspond 



48 Economics for the General Reader 

roughly with the class we in this country call " business 
men." The specialized laborers are collected and supplied 
with the necessary tools, machines, and material by one set 
of organizers ; to supply exactly the right kind and amount 
of labor with exactly the right kinds and amount of capital, 
and to keep them working steadily and harmoniously without 
waste of material, time, or energy, is a work requiring special 
knowledge and technical skill, and society relies on its " cap- 
tains of industry " to supply this knowledge and skill. What 
the head of the firm does along with other work, the foreman, 
the shop-manager, works-manager, general manager do as 
their special work ; they organize industry, they decide what 
shall be the exact division of labor, they decide in what form 
of tools and machines the capital of society shall be applied 
to industry — important work, even though the majority of 
them are content to copy their neighbors and follow a tradi- 
tional routine. 

II 

The Functions of the " Middleman " 

The Middleman. — But what of the specialized firm and 
the specialized trade? The division of labor has created 
gulfs not only between worker and worker, but between firm 
and firm and trade and trade. Who organizes firms and trades 
into the great productive mechanism that deHvered to us 
our two-dollar-and-a-half shirt made of Australian wool and 
Southern cotton in a New England mill? This work is done 
chiefly by the head of the firm again. In a large firm parts 
of it will be delegated to salaried employees, but for the general 
supervision of it the head of the firm is responsible. He buys 
the raw material, thus bridging the gulf which the division 
of labor has created between, say, the firms that weave flannel 
and the firms that spin yarn or import wool. He is respon- 
sible for the mill's equipment, thus bridging that other gulf 



The Organization of Production 49 

between the firms that make machinery and the firms that 
use it. But there is another class of organizers who do this 
work of linking together specialized firms and industries — 
the merchant or middleman class. Between every two 
stages in the productive process of any great manufacture will 
be found the merchant or middleman, acting as a bridge over 
the gulf : cloth is bought by tailors from merchants who 
bought it from manufacturers; yam is bought by manu- 
facturers from merchants who bought it from spinners ; wool 
tops are bought by spinners from merchants who bought the 
wool from other merchants, who bought it from the wool 
grower. It is by this middleman class that cooperation be- 
tween widely separated firms is organized ; without it our 
shirt would never have found its way half round the world and 
through New England from the sheep's back to ours. 

The Middleman a Necessary Link. — Popular opinion 
makes a sharp distinction between manufacturer and mer- 
chant, recognizing the organizing work of the former but not 
of the latter ; but the distinction does not correspond with any 
profound distinction of function. The special functions of 
the two are rarely quite separated in actual business ; both 
are organizers, and in the real sense producers. The manu- 
facturer buys raw materials, labor, capital equipment, and 
sells articles in a condition to be used either as raw material 
by another industry or as finished goods by the consumer. 
The merchant buys commodities in a condition to be used, 
and sells them where they are wanted ; without his collecting 
and distributing work the commodities would not be com- 
pletely '' produced," since they would not be in the places 
where they can be used. The division of labor between 
" manufacturer " and " merchant " is convenient. The first 
business of the manufacturer is to manufacture, which he 
does by organizing the cooperation of specialized workers, 
machines, and departments. But his business cannot be 
carried on unless there is a working connection between it 



50 Economics for the General Reader 

and the businesses which supply it with its equipment and raw 
material; and its work is useless unless there is a working 
connection with the trades or consumers who take its prod- 
uct. The establishment of this working connection is the 
middleman's special work. It may be done by the manu- 
facturer ; some of it always is ; but in most large trades there 
is a specialist, a merchant, to do it. 

The Factory Manager. — Every trade has to buy from 
other trades, and has to sell its products. This buying and 
selling is inseparable from specialized production. As the 
organizing work within the manufacture becomes more com- 
plicated, it tends to be done by a whole-time specialist. And 
similarly, as the connections between trades become more 
complicated, the work of maintaining these connections in a 
state of efficiency tends to become the exclusive work of a 
specialist. The two specialists may be the same firm; the 
tendency is perhaps for both pieces of work to be entrusted to 
salaried officials of the same firm. But the independent mer- 
chant — ■ simply because he specializes in the needs of a whole 
trade and not in those of a single firm — can usually offer 
facilities which make it " pay " firms to deal with him. Thus 
he organizes the cooperation of specialized firms and trade, in 
the same way as the factory manager organizes the work of 
specialized workers and machines. This is obvious where the 
processes of manufacture are carried on largely on commission. 
The merchant in this case bears the same relation to the com- 
mission comber, spinner, manufacturer, and dyer and finisher, 
as the general manager of a steel works does to the furnace, 
foundry, rolling mills, machine shop and fitting shops, or as 
the manager of a weaving estabHshment does to the warpers, 
winders, twisters and weavers, tuners, etc. 

Services of Middlemen. — The merchant and the shop- 
keeper are called "middlemen," however, not because they 
stand between firm and firm, between trade and trade, and 
connect them, but because they stand between " producer " 



The Organization of Production 51 

and consumer. We often bear them a grudge for standing 
there, and are reluctant to recognize that they perform any 
useful function in return for the profits they obtain. Com- 
merce and exchange are thought to be " unproductive," be- 
cause things do not alter their form by being exchanged. 
Such a view is based on a misunderstanding of the process of 
production. The obvious question which it suggests is. 
Why does exchange go on? Unless the parties to the ex- 
change are both better off by it, why do both agree to it? 
The objection ignores the obvious fact that the same thing 
may have different degrees of usefulness for different persons 
and at different places and at different times. Bananas are 
more useful to Enghshmen than to West Indians because 
West Indians have more than they can possible digest, and 
any one who brings bananas. from the West Indies to England 
is adding to the sum total of satisfaction in the world ; ice 
is more capable of satisfying wants in hot countries than in 
the arctic regions, in summer than in winter, and it does not 
make the slightest difference to the amount of satisfaction 
obtained from the use of ice in a hot summer whether the 
ice is imported from the arctic regions or saved in an ice cellar 
or manufactured. 

Nature of Middleman's " Toll." — The middleman stands 
between producer and consumer, but not to obstruct ; if his 
profits are a toll, it is a toll levied not at a toll-bar on an other- 
wise open road, but a toll for the use of a very necessary bridge. 
It would be impossible for the consumer as a rule to order 
directly from the innumerable producers who cooperate in 
the production of the simplest article ; it would be extremely 
difficult for the producers always to find the person who wants 
their product — even if any producer could perform the 
impossible task of identifying on the finished article his 
particular contribution to its making. The middleman helps 
both ; for the producer he finds a market, for the consumer he 
finds out what he wants and gets it for him. Just as the 



52 Economics for the General Reader 

suburban vegetable-dealer calls round on his customers for 
orders, so the middleman finds out what things are wanted 
and where they are wanted, and collects them with a view to 
satisfying these wants. If the shopkeeper's customers had 
to go direct for everything they wanted they would never 
get half their wants satisfied ; so the shopkeeper collects 
and stocks all the kind of things that they want and lets 
them have them at the time and in the form and amounts in 
which they want them. Of course the middleman does not 
passively wait for the consumer to say what he wants ; the 
consumer is usually a person of sluggish intellect who does 
not know what he wants, and the middleman can to some 
extent control the consumer's wants, by advertising or other 
ways of pushing sales; but his power in this direction is 
limited, and he could not carry on his business permanently 
by supplying customers with things which they do not want. 
In effect the middleman, whether merchant or shopkeeper, 
goes into the world of business and says to the producer, 
" Tell me what you produce and I will find you the man that 
wants it " ; to the consumer, " Tell me what you want and 
I will get it for you." He saves both producer and consumer 
trouble ; his profits are the charge he makes. 

Middleman Essential to Localization. — The merchant 
arose before the " captain of industry." Trade grew up 
before the division of labor had been carried far enough to 
require the organization of factories or workshops; for 
different regions have different capacities, and by exchanging 
their products all benefit. With the growth of modern 
industry, however, the middleman's work has become vastly 
more important. Buying in the cheapest market and selling 
in the dearest, he is performing an important part in the 
organization of industry. A thing is dear where it is wanted, 
it is cheap where it can be produced easily ; the middleman 
therefore encourages production where production is cheap 
and discourages it where it is expensive, and at the same time 



The Organization of Production 53 

directs goods from the places where they are wanted less to 
the places where they are wanted more. Commerce equalizes 
the supply of goods in the different parts of the world ; a few 
cents a yard on the price of cloth will divert an order from one 
country to another, a cent on the bushel of wheat from one 
continent to another. The locaHzation of industry is largely 
the result of the action of middlemen, and their function is a 
necessary function in an industrial organization which enables 
the consumer to have delivered at his door the products of 
every country, obtained where they are produced most 
cheaply. 

Ill 

Methods of Appointing the Organizers of Production 

Importance of Organization. — The organizer, then, whether 
manufacturer or merchant, is the pivot of the modern indus- 
trial organization. On the efficiency with which he organizes 
the cooperation of speciahsts the effectiveness of their work 
depends. On him the consumer depends for getting what he 
wants and not some makeshift. SpeciaUzation is the principle 
on which all increase in productive power depends — speciali- 
zation is effective only when the specialists cooperate, and 
with every increase in the degree of specialization the work of 
organizing the cooperation becomes more important and 
more difficult. 

Need for Right Kind of Organizers. — It is of the utmost 
importance, therefore, to the material well-being of society 
that the right men occupy this position. If they do not, 
there will be waste ; inefficiency there neutralizes the effi- 
ciency of scores or hundreds and even thousands of specialized 
workers, just as an incompetent general can ruin the finest 
army. Inefficiency in the organizer means that departments 
are held up because other departments are not ready for their 
product ; it means that some firms in the trade work overtime, 



54 Economics for the General Reader 

while others are not fully employed ; it means that articles 
are produced that the consumer does not want and will not 
pay for, while articles he does want are produced in insufficient 
quantities and, consequently, are to be had only at a fancy 
price. The organizers control the capital of the country; 
they decide, guiding themselves of course by reference to the 
demand of consumers, to what purposes it shall be appHed 
and in what form it shall be applied. Want of judgment on 
their part may result in the creation of forms of capital which 
are useless — as, for instance, when mills are put up to meet 
an increase in demand which never comes. OriginaUty and 
enterprise on their part, on the other hand, will make pro- 
duction cheaper and cheaper, since it will insure the appHcation 
of capital in those forms and at those points where it is most 
productive. They are society's paymasters ; to them the 
consumer hands the price of the goods which he consumes ; 
they distribute it between the different classes of workers, 
capitalists, and land-owners ; in a word they employ land, 
labor, and capital; competition between land, labor, and 
capital for the national income takes place through the em- 
ployer, and since the merchant employs the different em- 
ployers in the same way as they employ land, labor, and 
capital, the competition between different trades for the 
national income takes place through the merchant. They 
" represent," as it were, the consumer in his relations with 
producers. Their function, in fact, whether they perform it 
ill or well, is the organization of production; the method of 
their appointment and payment is a most important question 
in social politics. 

Importance of Efficiency of Organizers. — We have looked 
at the organizer from the point of view of society to find out 
what is his position in an industry, his relation to different 
industrial classes, and the service he performs ; the resulting 
picture is one which the business man might not recognize 
as his own portrait. This is natural, since the viewpoint of 



The Organization of Production 55 

society is diflferent from that of any individual. The business 
man looks at industry simply as a series of market trans- 
actions ; he buys at one price and sells at another, taking 
the difference for himself or standing the loss if the difference 
is against him. There is no inconsistency between the view 
he takes of himself and the view we have taken of him. Few 
people would recognize their own description by a physiologist 
or psychologist, but we do not therefore say that the de- 
scriptions given by physiology and psychology are untrue. 
At the same time it is necessary to guard against a possible 
misunderstanding. We have been trying to get at the work 
which the business man performs in the social organization 
of industry. We have found that the present organization 
of industry requires a class of organizers ; we shall find that 
it requires a class of risk-takers, and we find that the work of 
these classes is being done by the class of business men. We 
have not yet examined the question whether the business men, 
to whom the necessary and important work is allotted, do it 
well or not ; and in saying that the business men are the 
organizers and risk-takers of modern industry, we are not at 
all suggesting that the work of organization and risk-taking 
is done perfectly or even as well as it might be. That depends 
entirely on the efficiency of the business men ; all that we 
have done so far is to bring out the necessity and importance 
of this work of organization, and we have now to inquire how 
the individuals who have the charge of this work come to 
occupy the positions they do. 

Selection of Organizers. — How then are the organizers of 
industry appointed ? Some are appointed by the State ; the 
organizers of the German railways are so appointed ; most 
of the organizers of the tramway, electricity, water, and 
gas services in England are so appointed ; but such appoint- 
ments are only a small proportion of the total number of 
organizing posts in the community. It will be noticed that 
most of the instances of public appointments are in industries 



56 Economics for the General Reader 

the services of which are consumed entirely within the area of 
the particular pubHc authority. If the authority, therefore, 
is a representative body, we may say that these appointments 
are made by the consumers. Similarly the organizers of the 
great body of industry under the control of the cooperative 
movement are appointed by the consumers ; the directors of 
the Cooperative Wholesale Society in England are appointed 
by and responsible to, the customers of the Cooperative 
Wholesale Society; indirectly, therefore, the customers con- 
trol the appointment of the managers of separate departments. 
The Cooperative Movement. — There is another form of 
" cooperative " effort which has attracted an amount of 
attention out of all proportion to its extent and success, i.e. 
the association of producers in what are called self-governing 
workshops or cooperative productive workshops. Their 
history offers a marked contrast to the success of the Co- 
operative Store and Wholesale movement. In them the 
organizers are appointed by the workers in the industrial 
unit, and no system of appointment has such a record of 
recurring failure. Obviously the discipline and order which 
modern methods of factory production require will be hard 
to secure when the manager is responsible to, and controlled 
by, the people he manages. During the nineteenth century a 
new form of business unit has grown to importance in the 
Corporation, a form which we shall consider in detail when we 
are considering the organization of capital. In its essence 
it is an association of capitalists large and small to carry on a 
business by the employment of paid organizers. Here the 
organizers are appointed by the capitalists; the owners of 
the capital, the shareholders, elect the directors who do the 
chief work of organizing. They in turn appoint managing 
directors and general managers who appoint the different sub- 
ordinate managers. The ultimate control here hes in the 
hands of the people who supply the capital of the business, 
and this method of business organization is the most significant 



The Organization of Production 57 

of the present time for two reasons — first, in it the ownership 
and the employment of capital are separated ; secondly, the 
work of organization is separated from the bearing of risk, 
the former being done by specialized workmen for regular 
salaries, while the latter is undertaken by the shareholders 
to whom the profits go. 

Self-appointment of Organizers. — Important, however, as 
are these methods of appointing organizers, and significant 
as they may be for the future, they are none of them the most 
general method of appointing organizers at the present time. 
The great majority of the organizers in industry to-day simply 
appoint themselves. Since the Industrial Revolution the 
restrictions imposed by privileged gilds and corporations, 
and by the State itself, on the choice of occupations and 
freedom of trade have been relaxed, and a system of free 
enterprise or laissez-faire adopted. Laissez-faire is simply a 
policy of leaving any one free to set up business in any trade 
which he wishes. The State to-day does not, except in the 
case of a few professions, such as medicine and the law, 
prescribe special training for any occupation, or reserve by 
legal restriction the organizing posts in industry and com- 
merce for any special class. So far as the law of the country 
is concerned, any one is at liberty to take up any organizing 
work, that is to say, any one may start any business which he 
thinks will pay. In effect, the community announces, " If 
any one thinks he can satisfy any want, let him start a busi- 
ness to do so : if he succeeds, he shall have the profits of his 
enterprise ; if he fails, he and the people who have dealt with 
him shall bear the loss, for he will become a bankrupt." 



58 Economics for the General Reader 

IV 

Merits and Defects of the System of " Free Enterprise " 

Free Enterprise and Flexibility in Production. — This 
freedom of enterprise is the chief source of the elasticity of 
the modern productive organization. Individuals, being at 
liberty to avail themselves of any opening they can perceive, 
estabhsh new businesses or adapt old businesses to every new 
want. The rapidity with which new inventions like the 
automobile and the " movie " have been taken up and erected 
into important industries within the last generation, or the 
adaptability of the textile industries to changes in fashion, 
will serve as illustrations of this elasticity. Freedom of 
enterprise is the cause also of the complexity of the productive 
organization. The individual organizer, free to seek new 
markets for products and new sources of supply for wants, 
has spread a network of trade connections over the whole 
world. The managers of manufacturing firms have been 
free to experiment and adopt any methods of organization 
they found advantageous. Men of an organizing turn of 
mind, who have seen a defect or a need in the existing organi- 
zation, have been free to establish businesses to remove the 
defect or satisfy the need ; while the men who have not the 
capacity to originate have been free to copy. The place of 
free enterprise in the organization of production can be realized 
only by comparing the present system with the so-called 
" system of monopoly " which preceded it ; occupations were 
the monopoly of gilds and corporations which restricted 
entrance to them, methods of production were dictated by 
State or gild of&cials, and the flow of trade was confined, so 
far as the State could control it, by prohibitive tariffs, tolls, 
and export duties to certain selected channels. 

Defects of Competitive Selection of Organizers. — The 
principle which the opponents of this old " system of monop- 



The Organization of Production 59 

oly " sought to incorporate in the organization of society is 
essential to any satisfactory organization of production — 
the principle, namely, that production should be responsive 
to demand, and that individual organizers should be at 
liberty to experiment with new methods of production without 
waiting for the authorization of some Government depart- 
ment. The method by which they sought to secure their 
object was also sound — the method, namely, of relying on 
individual initiative and sweeping away all obstacles to its 
widespread exercise. Their reform, however, stopped half- 
way. It was a negative, not a positive reform. It swept 
away obstacles to individual initiative without doing much 
to create opportunities of initiative. A constructive states- 
manship, therefore, even if it left the present system untouched 
in principle, would seek to supplement the negative privilege 
of free enterprise by providing positive facilities at the public 
expense for research into processes of production, methods of 
organization, and openings for trade, and by increasing the 
educational provision which is the chief aid to equality of 
opportunity. As things are, the system of free enterprise, 
with the other methods which we discussed, has removed 
obstacles to the appointment of the most suitable people to 
the organizing posts of industry and commerce without making 
provision to insure that they shall be appointed. 

Situation in Great Britain and in the United States. — In 
spite of this defect, in the districts of Great Britain and the 
United States in which industry is most progressive, a majority 
probably of the responsible heads of firms have risen from the 
ranks, and a vast majority of firms have been founded by 
men who have risen from the ranks. The suitability of the 
small firm for the work of pioneering a new industry or new 
methods has provided the poor man of ability with his oppor- 
tunity in some cases, a boom in an established trade in others. 
Latterly the growth of corporate enterprise and the extension 
of State and municipal enterprise have thrown open organizing 



6o Economics for the General Reader 

posts to men without capital. Few people would maintain, 
however, that the best men are in every important post, or 
that there are no incompetent men in important positions. 
In judging the efficiency of the system, therefore, we have to 
consider not only the opportunities for the promotion of 
able men, but also the arrangements for removing from 
positions of control incompetent men. The arrangement on 
which the policy of free enterprise reHes is failure through 
competition, and competition is not sufficiently efficacious. 

Hereditary Selection of Organizers. — A large number of 
important posts in the organization of industry and commerce 
are filled by hereditary succession. In the private firm the 
son can succeed the father without any inquiry as to whether 
he is the fittest man for the work ; hence large branches of 
industry are controlled by people who are put into their posts 
without any competition. Once in, they can be removed only 
by their own resignation or by failure. Through failure, under 
the pressure of competition, the unfit are weeded out, but 
the doubt is suggested whether bankruptcy is not an un- 
necessarily expensive method of selection. A whole country- 
side may be ruined, because the son of the man who built up 
the business on which the countryside depends was born a 
fool. This danger is usually averted in their own interests 
by people who inherit businesses which they are not competent 
to manage, by the promotion of subordinates to the position 
of partners, or by converting the business into a corporation. 
The elimination of the unfit organizer by competition takes 
time, and during the interval in which he scrapes along he 
may do infinite harm, and at the best will cause great waste. 

Class Prejudice. — A second defect in the appointment of 
the organizers is the extent to which class prejudice influences 
such appointments. The extreme case is the appointment of 
" dummy " directors who receive the salary, even if they are 
not permitted by their colleagues to do the work, of organizers 
of industry. A more common but less obvious evil is the 



The Organization of Production 6i 

class feeling which makes the so-called " upper-class " con- 
trollers of industry unwilling to give workingmen their fair 
chance. The workingman of only average organizing abihty 
will probably get few chances of showing he possesses it; 
the workingman of exceptional organizing ability will not 
be kept back, but he has never so good a chance of promotion 
as the " upper-class " man of less exceptional ability. Much 
organizing work, the work of managing and marketing, can 
be reduced to a routine. Before it is reduced to a routine it 
requires ability of a high order, and as such commands high 
payment. When it has been reduced to a routine it does not 
require exceptional ability, but frequently secures the same 
payment through custom, and because the " upper-class " 
person who usually has it to do lives at the same rate and in 
the same social style as the few able men who are capable of 
work which is not routine. This is seen especially in the 
difference between starting a business and running one, be- 
tween making a fortune and keeping it. The exceptional 
man builds up a business and makes a big income out of it : 
his ordinary son, who could never have built up such a 
business, is capable of running it, and makes as big an income 
out of it as his father. Only when he is below the average 
ability and quite unequal to the work does he incur failure ; 
that is to say, so long as a man is born into the social class 
which does most of the organizing work in industry and 
commerce, and has merely the ordinary ability needed to 
maintain a traditional routine, the struggle for survival need 
not touch him. The owner of a large capital, who manages 
his business on conservative lines and chooses capable sub- 
ordinates, is in no danger of losing his important position. 

Effect of Inequality of Wealth. — Inequality of wealth is 
the great cause of inequaUty of opportunity, since some 
capital is essential to starting in business. The amount 
needed on an average is growing greater, and the advantages 
of a large over a small capital are also growing greater. The 



62 Economics for the General Reader 

privilege which the system of laissez-faire allows to every one 
to enter into competition with established businesses is an 
empty one, unless it is accompanied by some means of getting 
the use of capital. The means exist — we shall study them in 
a chapter on the orgam'zation of capital — but they certainly 
do not make the chances equal between " upper-class " and 
working-class men of equal ability. Even in the large 
corporations, which are opening new avenues of promotion 
to the poor but able man, the unconscious sympathy which 
" upper-class " people have for one another is probably an 
important influence in determining the exact selection of men 
for the most important position. America has a great 
advantage over the countries of Europe in that such class 
prejudices have less influence, and the career open to talent 
is more of a reality than in more conservative countries. Dr. 
Marshall has explained that the workingman who practices 
the vices of a miser, and restricts his life's activities resolutely 
to the making of money, can accumulate a considerable 
capital ; but he must have " a long as well as a strong life,'* 
and " patience, genius and good fortune " if he is to succeed. 
Given these conditions, he may rise enough to enable his 
children to rise further — if they also possess patience, genius 
and good fortune. But the recognition of this possibility is 
not inconsistent with accepting Marx's generalization that the 
leadership of industry is an attribute of capital, just as in 
feudal times the functions of general and judge were attributes 
of landed property. 

The Corporation and Specialization in Organization. — A 
class of organizers similar to the business men in the present 
industrial system is necessary in any organization of industry 
which avails itself of the economies of speciaHzation. And in 
the sphere of organization we can see the same specializing 
tendencies at work as in the rest of the field of industry. The 
corporation in which all organizing work is put into the hands 
of people who are specialized to it and is paid for by salaries, 



The Organization of Production 63 

is gaining on the private firm, in which the work of organization 
and the taking of risk are both performed by the owner of the 
capital. The taking of risks can never be quite separated 
from the work of organization, as will be seen in the next 
chapter ; but it is significant that salaries as a method of 
paying for the work of organization tend to displace profits. 



CHAPTER IV 

SPECULATION AND INSURANCE 

I 

Production as a Whole Carried on in Anticipation of Demand 

Nature of Anticipation of Demand. — In the last chapter 
we saw that one part of the organization of production con- 
sists in buying things in one place and selling them in another. 
The middlemen or dealers who do this act as a connecting 
link between specialized districts and between specialized 
trades, and also as a connecting link between all kinds of 
speciaHzed producers and the general body of consumers. 
This description, however, gives only one-half of the work of 
the dealer; the other half consists of the anticipation of 
demand, and of buying at one time and selling at another. We 
enter a shop, pay two dollars and a half, and a shirt is given 
to us. The shirt is the product of the labor of hundreds of 
people, the materials of which it is made were drawn from 
two or three continents, the machinery required to make it 
took months to construct ; yet we get the shirt without 
waiting. For us to get it the shopkeeper must have stocked 
shirts, for him to do so the wholesaler with whom he deals must 
have stocked shirts, for the wholesaler to do so some one must 
have manufactured shirts, some one must have manufactured 
the flannel from which they are made and the thread with 
which they are sewn, and further back still, some one must 
have made the machinery with which all these manufacturers 

64 



speculation and Insurance 65 

work. That is to say, in anticipation of our want of a shirt, 
a complex organization must have been at work for months 
and perhaps years before we announced our want. We saw 
in the last chapter that a special class of organizers existed 
to connect the specialists up into one productive machine ; 
we see now that these organizers do this work, not in response 
to our demand, but in anticipation of it. 

Involved Character of Demand Anticipation. — We bought 
a woolen shirt ; suppose we had wanted a cotton one. The 
retailer would probably have been able to supply us. The 
demand for the different kinds of shirts is fairly steady, and 
it is the retailer's business to know what to stock. But 
multiply our case a thousandfold, and suppose he has not 
anticipated our wants so exactly. What is the result then? 
First, he has woolen shirts which are not wanted, and all the 
series of people behind the counter, who have been contributing 
to the making of his woolen shirts, have been making some- 
thing which, as it happens, is not the thing wanted. Secondly, 
the shopkeeper, being unable to sell woolen shirts, orders 
fewer, and this check to the demand for woolen shirts is 
transmitted right through to the people who grow wool 
and make woolen-working machinery. Meanwhile, we, in 
our determination to get a cotton shirt, leave the shop and go 
elsewhere for it, and the shopkeeper telegraphs to his whole- 
saler for a supply of cotton shirts at the same moment as we 
at another shop are asking for a cotton shirt. Imagine a 
thousand people acting as we are acting, and the people whose 
business it is to supply cotton shirts will get the impression 
that there is going to be an increased demand for cotton 
shirts and will place their orders accordingly. Or suppose 
we were attracted by a brilliant and original tie, or a new 
thing in suspenders, or suddenly remembered that we want a 
straw hat, and, having only $2.50 in our pockets, decided that 
the shirt could wait ; then the trade both in woolen and cotton 
shirts would be disappointed, and we should be helping a boom 



66 Economics for the General Reader 

in ties, suspenders, or hats. There are similar possibilities at 
each stage in the productive process. The wholesaler buys 
from the jobber what he thinks will be wanted ; the jobber 
stocks or has ordered from the manufacturer what he thinks 
the wholesaler will want; the manufacturer (unless he is 
working to a jobber's orders) is similarly estimating what will 
be wanted ; and the machine-maker, the laborer, the agricul- 
turist similarly direct their efforts to making or growing what 
they anticipate will be wanted. 

Relation of Production to Demand Anticipation. — Pro- 
duction is carried on in anticipation of demand. This is 
inevitable if we are to avail ourselves of the economies of 
specialization, since specialization takes time. When we 
purchased the woolen shirt we were getting goods from the 
Australian sheep farmer, from the Southern cotton grower, 
from a whole host of machine-makers, builders, transport 
workers and others, who could not possibly have known of 
our existence nor anticipated for themselves what we should 
want. Again, all the processes of manufacture must be 
carried on simultaneously. The growing of the wool, the 
spinning, the weaving, the shirt-making, and the distributing 
by merchants and shopkeepers must be going on continuously 
and simultaneously, or a large number of people and large 
amount of capital would be unemployed. The shirt which we 
bought was perhaps begun two years ago, and with every stage 
in its manufacture the materials of which it was made become 
more and more useless for anything except the one purpose 
of making a woolen shirt. 

Production is carried on ahead of demand on an estimate 
of it. Working on an estimate necessarily involves the risk 
of loss when a wrong estimate has been made, and every class 
in the community has to some extent to meet this risk and 
bear a share of this loss. The consumer suffers because he 
does not get what he wants, or has to pay a high price for 
what he wants; the worker suffers because his speciahzed 



speculation and Insurance 67 

skill may suddenly lose its value. But the chief risk is borne 
by the class of organizers whom we studied in the last chapter. 
They take the first and chief loss if something is made which 
turns out not to be wanted. This is so because they have paid 
for the making of the thing before they could find out that 
it is not wanted ; in return, they take the profit if their 
estimate of what is wanted turns out to be correct, so that they 
are able to offer the public just what it wants and is willing to 
pay for handsomely. They are the class in industry whose 
business it is to anticipate demand, to divine what will be 
wanted and how much of each thing will be wanted, and their 
profits and losses depend as much on the correctness of their 
anticipation as they do on the skill with which they organize 
specialized producers. This side of their work is emphasized 
by the French term for the person who organizes production, 
entrepreneur, which imph'es undertaking production for the 
market with its attendant risks. 



II 

Speculative Dealing 

Universality of Speculation. — There is thus a speculative 
element in all business, due to the fact that it is carried on 
ahead of demand on an estimate of demand. When, however, 
we speak of speculation, we do not as a rule refer to this 
anticipation of demand. We should not call the action of a 
retailer in stocking his shop '' speculation," although there is in 
it the risk that the public will not want the stock he has 
selected. By " speculation " we mean the kind of business 
carried on by the dealer in cotton or wheat, and the word 
carries with it a suggestion of socially harmful action. A 
study of the nature and social effects of this speculation will 
throw light not only on the trades in which it is carried on, 
but on the organization of production as a whole. 



68 Economics for the General Reader 

Nature of Speculation. — The essence of speculation Ues in 
forecasting price movements and then bu)dng or selling for a 
profit. Having made his forecast, the speculator buys if he 
thinks prices are going to rise, sells if he thinks prices are 
going to fall. He looks to the future and works on an esti- 
mate ; he takes the risk of loss if his forecast is wrong in 
return for the chance of gain if his forecast is right. 

Social Effect of Speculation. — To discover the social effect 
of his action, it is necessary to inquire what he bases his 
forecast on, or, in other words, what are the influences that 
cause price movements. These influences are changes in the 
supply of the commodity he is dealing in and changes in the 
demand for it. He forecasts price movements by anticipating 
what the changes in the supply of the commodity or the 
demand for it are going to be : an increase in the supply or a 
falling off in the demand will cause prices to fall, a shortage 
in the supply or an increase in the demand will cause prices 
to rise. Hence the anxiety with which all the influences that 
can affect either the supply of or the demand for any of the 
staple commodities of commerce are watched and reported; 
the prospects of rain in Australia, on which the wool clip so 
largely depends, frost in the cotton belt of the United States, 
the weather in wheat-growing regions, are all under constant 
observation, and a steady succession of estimates of the coming 
yield in these regions is sent to the marketing centers. 
Similarly the demand is watched ; the prospects of trade in 
all departments are the daily study of thousands. Every 
daily paper has a considerable proportion of its space devoted 
to market reports, in which all the information is given which 
the paper can collect bearing on the probable changes in the 
supply of, and the demand for, the chief staples and local 
products. 

Operation of Speculation. — Let us suppose that the dealer's 
forecast is correct. Anticipating a shortage with no corre- 
sponding falUng off in demand, he expects prices to rise ; he 



speculation and Insurance 69 

therefore buys, intending to sell at a profit when the prices 
have gone up. His buying tends to send prices up now, higher 
prices now check consumption now. Hence present stocks 
are not exhausted so rapidly; some is saved for future use, 
and so. eases the pressure on the short supply which our 
speculator rightly anticipated ; in that way prices are pre- 
vented from rising so high as they would have done but for his 
action. Or suppose he anticipates an increase in supply and 
a consequent fall in prices ; he sells forward {i.e. he offers 
goods for future delivery at a price lower than the price at 
which they can be obtained for immediate delivery) ; his 
selling now tends to bring prices down, the lower prices stim- 
ulate consumption at once, so that present stocks are cleared 
and are not there to cause a glut when the big supply, which 
the speculator anticipated, comes into the market. Similarly, 
he will buy in anticipation of a rising demand, sell in antici- 
pation of a falling demand ; his action affects prices, so that a 
sudden change in demand does not produce a sudden change 
in price. It is, of course, the cumulative action of a large 
number of dealers in a sensitive market that has this effect. 

Influence of Speculation on Prices. — Speculation, then, 
buying and selling for a profit on a forecast, tends, if the fore- 
cast is correct, to lessen price fluctuations, by averaging supply 
and demand over a long period. The speculator, by varying 
prices, stimulates and checks consumption, always ahead of 
the change in supply or demand. This is a social service, 
provided that price fluctuations are inevitable, since sharp 
price movements mean fortunes for a lucky few, bankruptcy, 
unemployment, and distress for the many ; the interest of the 
community lies in steady prices. The speculator corresponds 
to the governor on a reciprocating steam-engine. 

Eflfect of Erroneous Forecasts. — It follows that, if the 
speculator's forecast is wrong, his action will be socially 
harmful, since it will accentuate price fluctuations. If, for 
instance, he sells, thinking that prices are going to fall when 



70 Economics for the General Reader 

they are really going to rise, his selling will for the moment 
tend to force prices down and stimulate consumption, so 
that when prices do go up they will go up higher than they 
would have done but for his action; and vice versa. Hence 
speculation, if it is to perform a social service, must be con- 
fined to specialists who are not likely to be wrong in their 
forecasts; the outsider coming into any market is a social 
nuisance. Society is not entirely defenseless against in- 
competent speculators. If the forecast is wrong, the specu- 
lator makes a loss and sooner or later fails ; but so long as he 
continues to operate he is a dangerous nuisance, and in his 
ruin, when it comes, he will probably involve others. Dealers, 
of course, do not look at themselves in this way. They look 
at their business simply as bujdng at one price and selling at 
another. They look at their business from the point of view of 
the individual, while we are looking at it from the point of 
view of society. From the points of view of both individual 
and society the speculator's profit is a difference in price ; 
from the social point of view, however, the important thing 
is that the speculator's action tends to lessen the price fluctua- 
tions out of which he makes his profit. 

Necessity for Speculation. — Are these price fluctuations 
then inevitable? It is only if they are inevitable that the 
speculator's action is necessary and his profits at all justifiable. 
In the present state of science, and in an organization of 
industry that avails itself of the productive economies of 
speciaUzation, it must be said that they are inevitable. They 
are due to two main causes which we will consider separately, 
fluctuation in demand and fluctuation in supply. 

Speculation and Fluctuating Demand. — Fluctuation in 
demand occurs because what people want and how much 
they want is always changing. It changes with fashion — 
the " hobble " skirt almost halved the demand for certain 
important classes of textiles ; it changes with the weather — a 
wet summer reduces the demand for muslins, silks, and 



Speculation and Insurance 71 

flannels, while it increases the demand for waterproof fabrics ; 
it changes with the general changes in prosperity. A war 
will cause a sudden and enormous demand for blankets, 
khaki, socks, boots, besides armaments, a demand which 
ceases just as suddenly when the war ends. Strikes and lock- 
outs are a similar influence of less importance. The demand 
for one commodity is influenced by its substitutes : when wool 
is dear, the demand for cotton will increase ; when cotton is 
dear, the motive for substituting it for more expensive fibers 
will be weakened. Industry cannot wait until demand has 
expressed itself, methods of industry being so round-about 
and prolonged. Production is carried on ahead of demand on 
an estimate of it ; some one has to make that estimate ; that 
" some one " is a speculator. 

Speculation and Fluctuating Supply. — More important, 
however, to the speculative dealer are fluctuations in supply, 
and speculation, in the narrow sense of the word, is found 
chiefly in the trade in raw materials such as cotton and 
wool, and foodstufl's such as wheat, sugar, coffee, where 
fluctuations in supply are greatest. They are greatest here, 
because the supply is not altogether under man's control ; 
man may decide how much land to sow or plant, the 
weather will decide what product the land will yield. 
Moreover, the supply of these commodities does not come 
into the market in a regular and even flow ; it comes in 
gulps, after the harvest in each producing region. The 
demand, on the other hand, is continuous and fairly 
regular ; for industry must be continuous. Cotton mills 
need cotton every month of the year, although cotton is 
harvested only two or three months in the year. Similarly, 
people want food all the year round, even though food is 
being harvested in one region during only a few weeks in 
each year. These two characteristics of trade in produce, 
the effect of weather and other natural influences on the 
amount of the supply in any year, and the seasonal or irregular 



^2 Economics for the General Reader 

nature of the supply as compared with the continuous and 
regular nature of demand, explain the speculative character 
of produce-dealing. 

The importance of changes in the supply of, and the 
demand for, commodities is due largely to the fact that they 
are immediately reflected in prices ; and the prices affected 
are not merely those of the raw material, but also those of all 
the commodities into which the raw material enters. A 
change in the supply of wool will afifect the values not only of 
stocks of wool, but of tops, yarns, and pieces ; a frost in 
Texas will cause an immediate rise in the prices asked not 
only for raw cotton in the United States, but for raw cotton 
in Lancashire and for yarns and pieces. Thus a change in 
values often occurs between the commencement and the 
completion of a single process of manufacture. A spinner 
may buy tops to spin, and, when his yarn is complete, find 
the value of it enhanced by the fact that wool has gone up ; 
a top-maker may buy wool in Sydney at one price, and get 
it to America only to find that some change in the con- 
ditions of the market has brought prices in the United 
States notwithstanding high tariffs almost to the level at 
which he bought in Australia. 

Specialization and Risk. — Specialization, then, introduces 
two inevitable risks into production which are absent from 
the primitive system under which each household produces 
the bulk of its own needs. The first is the risk that the esti- 
mate of the demand on which producers have acted will be 
wrong; the second is the risk that some change in supply, 
occurring after a process of production has been begun, will 
lower prices, so that the value of the product when completed 
will be less than the cost of production. The first risk arises 
from the fact that specialization takes time, so that production 
has to be carried on in anticipation of demand ; the second 
arises from the fact that industry, to be economical, must 
be regular and continuous, while the supplies of the most 



speculation and Insurance 73 

important raw materials are irregular and discontinuous. 
The risks mean occasional loss, the chances of profit are 
presumably equal. If the person who undertakes the risks 
can anticipate correctly the movements of demand and supply, 
he will always make profits and no losses. The profits of 
the dealer are the payment society makes for the work of 
anticipating demand and supply. 

Elimination of Risk. — It is conceivable, though unlikely, 
that these two risks involved in the organization of production 
on a basis of specialization might be eliminated. The risk 
due to fluctuation in demand could be eliminated by carrying 
on all production to order : we should not go to a shop and buy 
a woolen shirt, we should order it three years before we wanted 
it, in order that the wool producer might increase the supply 
of wool and other producers their facilities for handling it. 
To state this alternative is to show its inconvenience. The 
risk due to fluctuations in supply could be overcome by 
accumulating and maintaining a reserve or reservoir of prod- 
uce from which to meet and regularize natural fluctuations in 
supply ; this method was applied by Joseph to meeting the 
difficulties of Egypt under Pharaoh. The expenditure in- 
volved in estabUshing such a reservoir, however, and the 
capital tied up in it, would be enormous, making it possibly 
more expensive than the present system, and the existence of 
such a market for their produce might tempt growers to 
produce in excess of society's normal requirements. 

Ill 

The Use of Contracts to Shift Speculative Risks on to the 
Shoulders of Dealers 

Contracts and Risk Elimination. — The risks and profits 
of anticipating supply and demand are not taken by all 
businesses alike. By the use of contracts the risks of incorrect 



74 Economics for the General Reader 

anticipation can be concentrated at a few points, so that most 
of the people in an industry know nothing about them and 
are enabled to work as if they did not exist. An industry as 
a whole cannot work to order, but any firm in an industry 
and even whole stages in it can. By working only to contract 
a large number of firms, so to speak, " contract out of " the 
risk due to price movements, leaving other firms to speciaHze 
in forecasting these movements, and to bear the risks attach- 
ing to them in return for the profits to be obtained by correct 
anticipation of them. 

Middlemen as Risk-takers. — The tailor will keep only a 
small stock of cloth, but a large number of patterns ; he will 
buy the cloth only when the customer has chosen his pattern. 
Manufacturers in the worsted industry complain that whole- 
salers try to do the same, buying only when they have an order, 
and thus throwing on the manufacturer the burden of meet- 
ing fluctuations in the demand. The manufacturer in some 
cases, however, never makes for stock; he weaves patterns 
and sends them out, and manufactures pieces only to order. 
The spinner usually spins only on contract, i.e. the price 
which he is to receive and the amount he is to make are settled 
before he buj^s his material. But in every industry we reach 
at some point a stage or a group of firms which cannot wait 
for orders and then buy just sufficient raw material to meet 
their requirements at a price leaving them a profit ; they 
cannot, because they draw their material direct from Nature. 
They have not a continuous supply to draw on ; they have to 
buy when the harvest comes, without waiting for orders. 
They may buy up in the course of two months a year's supply 
of raw material. Again, the manufacturer, having got his 
order, can cover himself against loss due to a rise in the price 
of yarn before he has completed his order, by giving a contract 
now, while prices are at a level that insures him a profit, for 
all the yarn he will need ; the spinner can cover himself against 
the same risk of loss by giving a contract for his material 



speculation and Insurance 75 

as soon as he has got his order for yarn. But again there are 
firms that cannot cover. In the worsted industry the top- 
maker undertakes to supply tops or wool at any time of the 
year, but he cannot buy at any time ; he has to buy when the 
wool comes oflf the sheep's back, and the bulk of the supply is 
crowded into three months of the year. And behind him the 
farmer cannot wait for orders and limit his production to the 
amount of his orders, since the amount of his product depends 
so largely on the weather. By working to contract, and 
covering themselves by giving contracts for their materials, 
those firms that can do so forego the chance of gain from 
price fluctuations in return for security against loss from price 
fluctuations. The fluctuations remain, the risks and chances 
from which they contract out are not eliminated. What 
happens is that the risks of loss and the chances of gain are 
concentrated on the shoulders of middlemen — retailers and 
merchants at one end of the productive process engaged 
principally in anticipating demand, dealers at the other end 
principally in anticipating movements of supply. 

Thus the use of contracts enables one of the great draw- 
backs of specialization, namely the risks which it introduces 
into business, to be counteracted by a further application 
of the principle of specialization, namely, the specialization 
of dealers to the work of anticipating and bearing those risks. 
Even where a single firm undertakes both the organization 
of the processes of manufacture and the work of anticipating 
and bearing the risks of the market, the tendency to-day is 
for the two pieces of work to be put into different hands. 
The former is done to an increasing extent by salaried em- 
ployees ; the latter tends more and more to be the special 
work of the head of the firm, assisted by other salaried em- 
ployees. These make it their business to collect all possible 
information as to the supply of, and the demand for, the goods 
in which they deal. They acquire a special knowledge of the 
possibilities of public taste and fashion, of the sources of the 



76 Economics for the General Reader 

raw material, of all the special risks incidental to the trade ; 
and they can allow for all the special risks in quoting a price 
for goods to be delivered some time in the future. They could 
not give the reasons for their decisions ; but their judgment 
has the same ground of special experience that the skill and 
judgment of any other speciaHzed worker possesses. 

Influence of the Market. — They are helped by the organi- 
zation of trade in markets. A market was originally a place 
where buyers and sellers could meet. To-day they may still 
meet in a customary place, but cheap traveling and cheap 
communication have made the market-place no longer essential 
to business. The trade in every important commodity has a 
whole apparatus of aids to right judgment of the chances of 
the trade. The Exchange is the most important of these, 
where is concentrated the latest information as to quantities, 
prices, and sales, and rules are enforced to make business 
as simple and open as it can be made. The trade news- 
paper, or the business colmnns in the local newspaper where 
a trade is localized, give some information. An important 
part of the work of the government consular service is to keep 
business men posted in the wants and needs of foreign markets. 
And every trade includes in its working army a corps of 
scouts or skirmishers in the form of agents, travelers, and 
others who are in constant touch with customers, finding out 
the nature and extent of their future demand. What is 
called specially the " business side " of a firm is the machinery 
which society has devised for anticipating demand, since 
specialization requires production in anticipation of demand. 

Example of Risk Distribution. — A comparison of the chief 
textile industries will illustrate the tendency to specialization 
in risk-taking. In the cotton industry, which is the most 
advanced, the degree of specialization is very great; manu- 
facturers and spinners as a rule work chiefly to order, and con- 
tract for their raw material at the same time as they take the 
order for their product; the risks due to price-fluctuations 



speculation and Insurance 77 

are taken almost wholly by dealers in the raw cotton and by 
distributors. In the woolen industry, the least advanced, 
there is little specialization. It is usual for a firm to under- 
take all the processes of manufacture, and for the manufactur- 
ing firm to take the risks of dealing. In the worsted trade, 
which occupies an intermediate position between the other 
two, the risks are fairly widely shared, but there is a tendency 
for them to concentrate on middlemen, especially on the top- 
makers, the dealers in the raw material. The top-maker 
may buy direct from Australia, risking a fall in values while 
the wool is in transit. He buys his stock in large quantities 
during comparatively restricted seasons ; he will sell at any 
time. He will contract to supply spinners at any time, but 
he cannot get any one to contract to supply him. He needs a 
high degree of technical knowledge to deal in the wool, but 
his profits are chiefly obtained from forecasting price-move- 
ments. 

Now this tendency for speculation to concentrate in the 
hands of dealers is in accordance with the general tendency 
of economic development for work to be specialized ; the 
dealers are in constant touch with the market at many 
points, and they have no mill to manage. It is a desirable 
tendency, since we have seen it is essential if speculation 
is to perform a social service, that it should be well done, 
that the speculator's anticipations should be accurate ; and 
this can be secured only by people specializing in speculation. 
Moreover, different qualities are needed for dealing and for 
manufacturing, and the best organizer of a mill is not 
necessarily the best judge of price-movements. The reason 
that the tendency is not more general is that speculation, 
when successful, pays. The successful anticipation of price- 
movements is the quickest way of making a fortune ofifered 
by the modern economic organization, and manufacturers are 
loath to relinquish the chance of such gains, even in return 
for security against loss. Hence, to take the same example 



78 Economics for the General Reader 

as we took before, in the worsted industry only combers and 
dyers, who work exclusively on commission, and commission 
spinners and commission manufacturers, keep absolutely 
clear of the speculative field; they have their own risks, 
from trade fluctuations, but they are not concerned with the 
gains and losses that come from price-fluctuations. Spinners 
and manufacturers, who have the capital to do it, although 
as a rule they work to order and contract for their raw material, 
are usually open to buy up raw material when it seems cheap, 
and to work for stock when orders are not coming in. Both 
operations are speculative, since prices may change between 
the time when they buy the raw material and the time when 
they have completed their product; if prices rise they will 
make a profit over and above the normal profit of manu- 
facture, if prices fall they will make a loss. It is because 
speculation is so much more specialized in the cotton trade 
than in the worsted trade that corporations are so much 
more common in the former than in the latter. Corporate 
enterprise, as we shall see in the next chapter, is well adapted 
to the conduct of the manufacturing operations of a trade, 
while the private firm is more suited to dealing with its 
speculative element; in the cotton industry manufacturing 
operations and dealing are kept apart, in the worsted industry 
they are often combined. 

IV 

Terminal Markets for Dealing in Futures 

Nature and Influence of Future Markets. — A refinement 
of speculation, leading to a further concentration of risk-taking, 
exists in the terminal markets for dealing in futures, which 
are now found in connection with the trade in many raw 
materials and foodstuffs. Their nature will be understood 
best perhaps by an account of a single one of them. In 
England you can buy tops for future delivery, but you will 



Speculation and Insurance jg 

have to take delivery ; in Roubaix-Tourcoing, the chief 
French woolen center, you can buy the standard top for 
delivery any month up to twelve months ahead, and, at any 
time before delivery becomes due, cancel the contract by 
paying (or receiving) the difference between the price at which 
you made the contract and the price at which the top stands 
now for delivery in the month of the contract. The essentials 
of this organization for dealing in futures are an official price- 
list, a class of brokers, and a clearing-house and bank. In 
Roubaix-Tourcoing the list is published after morning and 
afternoon business ; it gives the price at which the standard 
top can be bought for delivery any month up to twelve 
months ahead, and is based on information of business done 
which is suppHed by the brokers. The brokers are bound 
to give this information ; they are not allowed to buy or 
sell on their own account. The clearing-house with which 
all transactions on the market have to be registered is called 
the Caisse de Liquidation et Guarantie, and it controls the 
market by guaranteeing that accounts shall be paid. The 
unit of dealing is the filiire, or " lot " of five thousand kilo- 
grams. 

Buying Futures. — Suppose I wish to buy futures. I must 
act through a broker, who finds a broker acting for some one 
wishing to sell ; buyer and seller must both through their 
brokers register the transaction with the Caisse, and must both 
within twenty-four hours make a deposit with the Caisse 
of looo francs per fihere. Then every time the list shows 
a change of five centimes per kilo, either the buyer or seller 
must pay in to the Caisse the difference ; if the price has 
gone down, the buyer pays ; if it has gone up, the seller 
pays. For example : I buy 5000 kilos for delivery in October 
at 6.10 francs per kilo, and deposit icx>o francs. Suppose the 
price falls to 6.05 francs, I pay in to the Caisse the difference 
(250 francs). The value of the tops to which I am entitled in 
October is now only 6.05 X 5000 francs ; I have contracted 



8o Economics for the General Reader 

to pay for it 6.10 X 5000 francs; therefore, to insure my 
ability to pay, the Caisse insists on my depositing the differ- 
ence. The price rises to 6.10 again, and I withdraw my 250 
francs. It rises still further to 6.15, and the seller has to 
deposit 250 francs ; he has contracted to deliver tops in 
October in return for a payment of 6.10 francs per kilo, he 
will not be able to get them for less than 6.15 per kilo; he 
must therefore provide the difference. The result is that when 
October comes there will be in the Caisse not only the original 
deposit but also an additional deposit, equal to the difference 
between 6. 10 francs per kilo (the price at which the contract 
was concluded) and the current (or " spot ") price for the 
top. If the current price in October is higher than 6.10 
francs, the seller will have deposited the difference, and with 
this deposit and the 6.10 X 5000 francs which he will receive 
from the buyer, he will be able to pay the current price for 
the tops and dehver them. If the price is less than 6.10 
francs, I, the buyer, shall have deposited the difference, and 
having this deposit at my disposal shall be able to pay 6. 10 X 
5000 francs, although the tops are not worth that sum at the 
current price. The essential thing in this arrangement is 
not the original deposit (which is merely an additional security 
for solvency, required on this particular market) but the 
regular payment of " differences " as they occur. On this 
account, it is the exception to take delivery ; nearly always, 
some time before delivery becomes due, the buyer accepts 
or pays the difference due to him or from him and cancels 
the contract. What the buyer buys is not so much wool to be 
delivered in October, as security against loss from an un- 
favorable movement of prices between the time when he 
makes his contract and October ; the transaction in fact is a 
kind of insurance. This will be clearer if we consider who use 
the terminal market. 

Selling Futures. — The sellers of futures are usually either 
importers of wool or manufacturers or spinners working for 



Speculation and Insurance 8i 

stock. Their object is to hedge. The importer, having 
bought in South America, is anxious to protect himself 
against the loss he would suffer if prices fall while the wool 
is in transit more than he has allowed for in deciding what 
price he could pay. He therefore wires to his representative 
at home to sell futures for the month when his wool will have 
reached Roubaix. If the prices have fallen by the time the 
wool reaches Roubaix, his loss on the sale of it will be balanced 
by a gain on his future transaction, for prices will have fallen 
in the futures market as well as " spot " prices, and the 
person who bought his future will have to pay him the differ- 
ence. Similarly, a manufacturer working to stock will sell 
futures ; then if prices fall to such an extent that they do not 
cover his costs and he has to sell his product at a loss, he will 
have his futures transaction to compensate him, since there 
will have been a corresponding fall in prices there, and the 
buyer of his future will have to pay him the difference. Of 
course the hedge is not complete, and such as it is, it is secured 
only by sacrificing the chance of a gain from prices going up ; 
but where large operations are being carried on on a limited 
capital, the security obtained by this method will usually lead 
to its adoption. The buyers of futures are merchants and 
top-makers of different kinds who have contracted to supply 
wool, tops, or yarn for some time ahead. They " cover " 
themselves by buying futures to an equivalent amount and 
for the same time ahead as their contract. Then if prices 
rise more than they anticipated and they have to pay for the 
wool, tops, or yarn more than they will get under their con- 
tract, the loss will be covered by the profit they will realize 
on their futures owing to the rise in prices. Similarly, 
spinners and manufacturers will sell futures, if they do not 
wish to give a contract for their raw material, and yet wish to 
cover themselves from loss due to a rise in prices. None 
of these buyers probably will take delivery of the tops they 
have bought when the future matures, because the top which 



82 Economics for the General Reader 

the seller can tender may not be suited to their purposes; 
they will simply take the difference — and it will enable them 
to purchase without loss the exact kind of wool, top, or yarn 
they want. All these buyers and sellers sacrifice a chance of 
gain to insure against a possible loss. 

The Professional " Future " Dealer. — There is yet an- 
other class of buyers and sellers. The importers, spinners, 
and manufacturers, who avail themselves of the terminal 
market to insure themselves against loss from price-fluctua- 
tions, have not abolished those fluctuations ; if they do not 
take the risks, some one else must. The most important 
persons in future dealings are those dealers who act as middle- 
men between the buyers and sellers described above. They 
are always wilHng to buy or to sell, provided they can get 
their price ; hence it is they who really fix the prices of 
futures. They make a hving solely by forecasting move- 
ments of prices, and buying or selling to make a profit. 
Their work is speculation pure and siniple, since they never 
use the material in which nominally they deal. Their work 
represents the highest degree of speciaHzed risk-taking, and 
is justifiable, since their buying and selling will tend to even 
price-fluctuations, so far as the forecasts on which their profits 
depend are accurate. 

Futures and Gambling. — Thus a futures market concen- 
trates at one point, almost one might say on one price-Hst 
the forecasting of price-movements. It tends to concentrate 
the work of speculation on one class who do nothing else, 
enabling the manufacturer, distributor, and importer to 
cover themselves or hedge against any loss from price-fluctua- 
tions. The advantages of the institution are obvious; its 
disadvantages are equally obvious. It makes the separation 
between the speculative side and the technical side of dealing 
so complete, that outsiders, who have no technical knowledge 
of the trade and no stake in it, are able to come in and specu- 
late. By substituting the payment of " differences " for the 



speculation and Insurance 83 

payment of the full price of the commodity dealt in, it pro- 
vides a further encouragement to outsiders to come in and 
gamble, and tempts dealers with small capitals to undertake 
operations that require for safety a larger capital than they 
possess ; it is in fact an encouragement to gambling. At 
the same time this economy of capital is a great advantage, 
since the moving of cotton for example from the United 
States to Lancashire is such a large operation and crowded 
into such a short space of time that it could hardly be carried 
out on a basis of full money payments. The existence of 
the price-list results in " unofficial " speculation outside the 
organized exchange or market, out of their control and sub- 
ject to none of the strict regulations imposed by them to 
prevent gambling. Finally it is alleged that organized 
future dealings, by making the market more delicate and 
sensitive, make disturbance more easy and facilitate the 
artificial price-movements of which we have to speak in a 
moment. It must be remembered, however, that speculation 
is not confined to futures ; it is inherent in all trade. The 
futures market merely concentrates, and perhaps multiplies 
it. There is as much speculation in the worsted industry in 
Bradford, which will have no terminal dealing, as in Roubaix, 
which has organized and clung to its " terme " in the face of 
the persistent attacks of other French woolen centers. 

V 

Illegitimate Speculation 

Test to be Applied. — Having described the nature and 
effects of speculation in general, we are now in a position to 
discuss what kinds of speculation are illegitimate. Two 
preliminary observations may be made. Mere buying and 
selling by people who neither produce nor use the material 
dealt in is not necessarily illegitimate ; as we have seen, the 



84 Economics for the General Reader 

buying and selling of an expert, who accurately forecasts the 
movement of prices, has the effect of lessening the price- 
fluctuations out of which he makes his profit. Secondly, we 
cannot at present look for a canon of legitimacy to the motive 
of the speculator. He is often neither conscious of, nor 
interested in, the social effects of his action, looking only to 
his private profit ; he represents his business to himself as 
merely selling at one price and buying at another, and the 
margin between the two that he aims at can be secured by 
hurting as well as by serving society. It is the effects that 
justify or condemn speculation. 

The " flyer." — We can begin by declaring illegitimate and 
wrong any speculation by the outsider. Every material 
dealt in requires careful study, and the outsider who has not 
made this careful study is not likely to estimate accurately the 
force of the different influences affecting its supply and 
demand. If his anticipations are wrong, his action will 
accentuate instead of lessening price-fluctuations, and may 
upset the calculations of legitimate dealers who have given 
all their time and efforts to studying the material. The 
outsider then, who comes into any market to speculate, is 
a social nuisance. It should not be necessary to state this, 
but successful speculation is so profitable that people are 
tempted to ignore the dictates of common sense. 

Adequate Capital. — The second kind of illegitimate spec- 
ulation that we can distinguish is deaHng on insufl&cient cap- 
ital. A dealer should obviously not engage in transactions 
so great that, if his forecast of prices is wrong, his loss will 
amount to more than his capital. If he does, he is risking 
bankruptcy, which will involve others, on the chance of 
making a fortune ; if his forecast turns out to be correct, he 
rakes in big profits ; if it is wrong, he is unable to fulfill the 
obHgations which he contracted, and is not only ruined him- 
self — it is perhaps as well that he should be — but involves 
in his ruin others who had rehed on his contracts. Expecting 



speculation and Insurance 85 

a fall, he sells forward ; a rise instead of a fall in prices takes 
place, and he is unable to deliver the goods which he sold and 
on which his customers are relying. It is this kind of dealing 
on insufl&cient capital that is chiefly responsible for the evil 
associations of the word " speculation." It is a variety of 
the old game of " heads I win, tails you lose." 

Manipulation. — The third, and worst, kind of illegitimate 
speculation consists in producing artificial price-fluctuations. 
Industry as a whole, we have seen, is carried on not in response 
to demand — with the price to be received for the product 
settled before the production is begun — but in anticipation 
of demand, with the price a matter of uncertainty till the 
whole process of production is completed by the transfer 
of the product to the consumer across the shop-counter. 
This fact forces upon industry the need of forecasting the 
movements of prices, in order to prevent an expenditure on 
producing a thing greater than the price which the thing 
will fetch when produced. This forecast is made on the 
assumption that prices are the outcome of the interaction of 
supply and demand. It is assumed that a rise in price 
indicates either a coming shortage in supply or an increase 
in demand, a fall in price either an increase in supply or a 
falling off in demand ; if the assumption is not justified, 
business becomes the merest guesswork. Price is the indi- 
cator that business follows. 

Evils of Manipulation. — Now it is possible to falsify this 
indicator, and to produce price-movements which are not the 
outcome of the interaction of supply and demand. This is 
done in two ways ; first, by spreading false reports as to the 
state of supply or, less frequently, of demand ; second, by 
buying or selling in direct opposition to one's forecast of 
price-movements in order to accentuate price-fluctuations. 
For example, an operator, or syndicate of operators, who be- 
lieve that prices must go up owing to a coming shortage in 
supply, will spread reports that there is going to be a glut or a 



86 Economics for the General Reader 

falling off in demand. This will give the impression that 
prices are going to fall. But more effective than any report 
in creating that impression will be their action in the market. 
By sudden and extensive sales forward they will force prices 
down ; other people, who would normally have followed the 
indications of the market and bought for a rise, will think 
that the operators are acting on private information and will 
therefore follow their example and sell, thus helping to force 
prices still lower. Meanwhile the syndicate will secretly 
have been buying up all they can get; when prices have 
been forced down as far as they are likely to go, they will 
buy openly also, and perhaps be able to secure a large pro- 
portion of the entire supply for months ahead. As a result 
of the shortage which they foresaw and which now operates 
unchecked, prices will rise high ; as a result of the syndicate's 
sudden and extensive buying they will rise higher than would 
otherwise have been the case, and the syndicate's profits will 
consist, not merely of the margin between the price ruling 
when they foresaw the coming shortage and the price ruling 
when that shortage began to be felt, but of the much wider 
margin between the level to which they artificially depressed 
prices and the level to which they artificially raised them. 
Such action is easiest in a terminal market where the operators 
will not have to pay the full price of purchases or deliver the 
goods when they sell, and its possibility is a strong argument 
against making speculation too easy ; it is possible, however, 
and it is done in ordinary commerce where there are no 
terminal dealings. Morally the action of falsifying the indi- 
cator which business follows is precisely the same in kind as 
the action of the wrecker who falsifies coast lights to mislead 
ships ; it is infinitely worse in degree. 

Stock Speculation. — The last kind of speculation, which 
would seem to be illegitimate, is speculation that cannot have 
the effect, which legitimate speculation has, of adjusting 
supply to demand. On the produce exchanges supply, we 



speculation and Insurance 87 

saw, is not a fixed amount, but a flow that varies in volume ; 
by raising and lowering prices speculators check and en- 
courage consumption, and in that way secure that supply shall 
be "averaged" from one period to the next, with the result 
that price-fluctuations are lessened. This action is necessary, 
only because the supply is an irregular flow ; if the supply 
were a fixed amount, there would be no need, and therefore no 
social justification, for speculation. The latter would seem 
to be the case in two important fields of speculative dealing, 
namely. Stock Exchange Securities and Land. Of course 
the floating of new companies and the issue of new shares 
to meet what is thought to be an unsatisfied need in industry 
involves risk, the same risk as attaches to starting any new 
business ; since new businesses must be started, and the risk 
is inevitable, the bearing of this risk is also inevitable, and a 
social service, and the profit obtained in the subsequent sale 
of these shares represents a payment for something done. 
But the Stock Exchange exists to facilitate, not the starting 
of new companies, but the buying and selling of shares in 
established companies, and what service to society is per- 
formed by the man who buys shares at one price and sells 
them at a higher price a Httle later it is difficult to see. Deal- 
ing with shares has no influence in adjusting supply to demand, 
because the supply of shares of any company is ai fixed amount, 
not an irregular flow. Land is similar; so far as dealing 
with land can be separated from the work of developing areas, 
which without that development would remain unused, land 
comes into the same category as shares. Its supply cannot 
be affected by changes in its price, seeing that it is not a flow, 
but an amount more or less fixed by nature. A middleman 
may perform a service by bringing together buyers and sellers 
who otherwise might have had difficulty in finding each 
other ; but speculation in land, the buying up of land in 
anticipation of a rise in its value, is of no service to society. 
This has been recognized on the continent and in England 



88 Economics for the General Reader 

by the imposition of special taxation on profits made from 
the sale of land; tax authorities generally might very well 
consider the desirabihty of imposing a similar tax on the 
" imearned increment " of Stock Exchange Securities. 

The State and Speculation. — A word may be permitted on 
the attitude of the State towards speculation on produce 
exchanges. Legislation is of little use as a check on illegitimate 
speculation, since it would be so difficult to devise a check on 
illegitimate speculation which would not act equally on the 
socially necessary speculation of legitimate dealing. The 
most practical check on illegitimate dealing lies in the diffusion 
of a feeling that the practices described above are dishonor- 
able, and the men who practice them dishonored. And the 
chief aid to establishing such a feeUng is a clear understanding 
of what kinds of speculation are necessary and legitimate, 
and what kinds are socially harmful. The State can help 
also by increasing the amount of information available for 
forming a judgment of available and future supplies — inter- 
national action may be necessary to secure this end — and by 
making all business transactions as open and public as possible. 
Speculation on the Stock Exchange on the other hand could 
easily be stopped by any government that wanted to stop it. 

VI 

Insurance and Other Methods of Meeting Risks 

Nature of Insurance. — Another method that society has 
evolved of meeting risks and minimizing the inconvenience of 
unexpected happenings is the method of insurance. When- 
ever a risk is regular enough for the loss to be calculated, 
where the loss is Ukely or certain to come at some time or 
other, it can be distributed over a number of years in the 
form of a small regular payment, and can be charged on the 
cost of production. It is known, for instance, how often on 



speculation and Insurance 8^ 

an average a mill is burnt down. Usually the loss involved 
would niin the business ; but actuaries can calculate how much 
must be set aside each year to meet such a loss ; and when 
spread over a number of years the loss is not crushing. By 
this method of averaging risks over a number of years an 
individual can provide against ruin from the greatest disaster. 
But he would find it very expensive, and most risks are insured 
cooperatively ; a large number of individuals contribute to a 
single fund from which all can be indemnified in case of loss. 
Where a large number of individuals pool their risks in this 
way (by taking out policies with the same insurance com- 
pany) the contribution which each need make towards the 
insurance fund is much smaller than it would be if they pro- 
vided against the risks separately; for the chances that a 
number of firms will, say, all have their mills burnt down is 
much smaller than the chance that one will. Insurance is 
sometimes compared with gambling; it is, in fact, the very 
reverse. The gambler converts a certainty into an uncer- 
tainty — the certainty that he has his money, into the un- 
certainty whether he will have more or less in the future. The 
insurer converts an uncertainty that he will be able to meet 
his obligations in the event of a possible misfortune into 
the certainty that he will. But while we can insure against 
loss by Burglary, Bursting Boiler, Accident to Person, Prop- 
erty and Plate Glass, Diseases (specified or unspecified), 
Forged Transfer, Violation of Trust, as well as Fire, Death, 
and the necessity of compensating an injured employee, the 
chief risks of business are not capable of actuarial calculation, 
and have to be met by the specialized instinct of the business 
man. 

Combination and Risk Elimination. — The desire to abolish 
risk, to remove the uncertainty of getting a supply of materials 
at a uniform price, and the uncertainty of getting a market 
for products at a remunerative price is the motive of some 
very important tendencies in business organization. Firms 



90 Economics for the General Reader 

engaged in manufacturing are reaching forward to the con- 
sumer, and backward to their raw material. The big steel 
firms have acquired their own iron deposits and their own 
coal mines. In this way they safeguard themselves from 
disadvantageous fluctuations in the price of their raw material. 
Clothing and shoe manufacturers are opening their own retail 
shops ; by so doing they get into direct contact with the con- 
sumers of their products and hope to anticipate their demands 
more accurately. Probably the desire to " steady " business, 
to prevent the recurrence of slump and boom, of under- 
production and the feverish ejEfort to take every advantage 
of an increase in demand, is a chief motive in those com- 
binations of competing firms which are the most striking 
feature of recent 'industrial history. A combination may 
secure a monopoly, but without securing monopoly, it can 
benefit its members greatly by letting them know definitely 
how much is being put on the market. Nothing is so dis- 
turbing to the business man's calculations as an unexpected 
" dumping " of goods on the market by a competitor. That 
can be stopped, if all the competitors combine to regulate 
the output of the whole trade. 

Risk and the Nature of Demand. — One other consideration 
must be mentioned before we leave this subject. Much busi- 
ness is routine. Our demand for the most important commod- 
ities — as distinct from the supply of produce — is stable, 
and can be easily anticipated. Where it is unstable, where 
it is likely to be influenced by fashion or whim, we are very 
willing to be led ; and the people who lead us are the people 
who have to anticipate our wants. Even when we refuse to 
be led, when our probable demand is most incalculable, the 
task of anticipating it does not fall on every one in the trades 
that supply our wants. In each trade a few big firms, a few 
prominent personalities, lead; the estimation of future 
demand is the work of a few people ; the great bulk of busi- 
ness men are content to follow their lead. The big fortunes 



Speculation and Insurance 91 

of trade are ihade by leaders, the men who foresee what is 
going to be wanted, and have it ready when it is wanted. 
But a large number of little fortunes can be made by their 
less enterprising and less far seeing followers who settle in 
the trade when they have opened it up, who content them- 
selves with supplying, at a moderate profit, the things which 
are always wanted, and wanted in about the same quantities. 



CHAPTER V 

CAPITAL AND ITS ORGANIZATION 

I 

Functions of Capital in Modern Industry and Commerce 

Nature of Capital. — It should be obvious by this time that 
a society that avails itself of the economies of the division of 
labor must have " something in hand " ; it must have some 
store of saved-up wealth which it can use to aid it in further 
production. Wealth saved up and used for this purpose is 
called capital. Any wealth may be used as capital, provided 
it fulfills this condition — that it is used, not by the final con- 
sumer, but by some producer to aid him in his productive 
work. Capital has three chief functions in an economic organi- 
zation like the present one — (i) in the form of tools, instru- 
ments, " plant," it makes man's labor on Nature infinitely 
more productive than it otherwise could be ; (2) in the form of 
stocks of goods, articles ready for consumption in warehouses 
and shops, materials awaiting manufacture, and so on, it 
enables us to adopt the roundabout and very productive 
methods of production to which specialization leads; if 
society was living from hand to mouth and had no savings, 
no store of wealth to aid it in further production, every member 
of society would have to occupy his whole time in digging and 
hunting for bare food ; and (3) in the same form it enables 
us to take risks — to produce in anticipation of demand in- 
stead of waiting for orders, to experiment with new processes, 
new materials, new markets, whenever we think there is a 
chance of our gaining by taking the risk. 

92 



Capital and Its Organization 93 

Importance of Capital to the Individual. — Such are the 
uses of capital to society ; to the individual business man its 
services are even more obvious. The manufacturer must 
have his factory, his machines, his power plant ; these are 
all so much fixed capital. He must have constantly a large 
supply of raw and partly manufactured material, which 
brings him nothing in until it is finished and sold. He needs 
some capital to meet the fluctuations of his business ; nor- 
mally he may meet the expenses of his present manufacture 
with the proceeds of the sale of past manufacture, but the 
receipts may lag a little while the expenses continue and he 
must have something in hand, some working capital, to cover 
this margin. Similarly the middleman must carry some 
stock ; his business is to have things where and when they are 
wanted ; he must therefore stock them in anticipation of 
demand ; the retailer's stock corresponds to the manufacturer's 
plant. In wholesale trade, stock is less important than 
formerly ; the telegraph, the telephone, and the railway make 
it less necessary. The merchant undertakes to supply his 
customers with anything in his line that they want. Though 
he has undertaken to supply it he has probably not got it ; 
the modern merchant does not buy and then sell, he more 
frequently sells and then buys. He does not buy things on 
the chance of selling them, he likes to be sure of his market 
before he commits himself to any buying. His specialized 
knowledge consists in knowing where things are wanted, and 
where they can be got, in foreseeing how much will be wanted 
and how far the supply will go. Thus he is constantly 
undertaking to supply goods and then covering himself by 
buying ; his constant endeavor is to be fully covered without 
having overbought. So long as he is quite successful in this 
endeavor, he uses his capital for such purposes as giving credit 
to customers while he has paid cash, meeting bad debts, and 
taking advantage of any offers of goods so cheap that they are 
worth taking, even though he may not at the moment know 



94 Economics for the General Reader 

of any market for them. But he camiot be sure of being 
able to cover himself immediately. He may make a contract 
to supply goods at a certain price and then, owing to some 
change in the conditions of the market, be unable to buy them 
except at a higher price. As we have seen, it is his business 
to take such risks. He relieves his customers of some of the 
trouble of watching the market, he gives them their materials 
at a steadier price, and in return he makes them pay him 
rather more than he, specializing in watching the market, 
can, as a rule and on the whole, get them for. Obviously, 
however, these risks can be taken only by a man with some 
capital. 

Granted, then, the importance of capital, the questions 
arise: Who controls this capital? What security, if any, 
have we that it is in the hands of the people who can use it 
most effectively? What organization exists for collecting it 
and putting it at the disposal of the organizers of industry 
and commerce? So essential is capital to modern business 
that these questions really amount to the same thing as an 
inquiry into the different types of business organization, 
the different legal forms a firm may take — an inquiry we 
have already begun in considering how the organizers of 
modern industry are appointed. 

II 

Conditions Requisite for the Accumulation of Capital 

Capital and Saving. — There is only one way in which 
either society or individuals can accumulate capital, that is, 
by consuming less than they produce. A modern society, 
if it is in a healthy economic condition, lives well within its 
income ; consequently it starts each new year with a bigger 
supply of tools, machines, materials, and wealth ready for 
consumption than it did the previous year. But there is 



Capital and Its Organization 95 

nothing inevitable or automatic about this accumulation of 
wealth. Many individuals and most governments live beyond 
their income ; governments are particularly bad offenders, 
for, being unable to resist the temptation to indulge in wars 
which they cannot really afford, they are continually throw- 
ing their hability in the form of national debts on to future 
generations ; and society only keeps up and adds to its supply 
of capital because the individual members of it, on the whole, 
spend less than they get. 

Saving and Security of Property. — What are the condi- 
tions under which we may expect individuals to save, so that 
capital accumulates? The first and essential condition is 
security of property. It is not intended by this to suggest 
that the existing rights of property must necessarily be 
maintained. The "rights of property" may vary from 
country to country and from time to time, but at any given 
time and country there must be security, or capital will not 
accumulate ; just as the worker will be an indifferent producer 
if employment is irregular and wages are uncertain. If the 
government cannot maintain law and order, or if its ofl&cers 
use their position to abuse instead of protecting its citizens, 
if the unfortunate producer is never certain how much of his 
product he will be able or permitted to retain, then the pro- 
ducer will produce little, and will take steps to secure for 
his own use all that he does produce, by consuming it all 
immediately. 

Saving and Remunerative Investment. — The second con- 
dition is that the person who saves should have oppor- 
tunities of using his savings remuneratively ; this was 
shown by the new openings for investment provided by the 
mechanical inventions of the Industrial Revolution, and by 
the institution of banks and corporations, which all stimulated 
the accumulation of capital. There are cases, of course, 
where foresight and imagination are so highly developed 
that the owner of wealth is indifferent whether he gets the 



q6 Economics for the General Reader 

use of it now or in the future ; in such cases saving is easy, 
and will go on almost irrespective of the rate of interest. 
But most people find it difficult to save; the enjoyments 
that can be secured by spending attract, and they forget the 
future. Communities and classes differ in this respect as 
well as individuals. It takes time for a habit of saving in 
a community to be developed. The traditional savage — = 
happy man — does not worry about the future, and will not 
usually forego a present satisfaction though he might gain 
thereby a much greater satisfaction in the future ; the French 
peasant, on the other hand, sometimes thinks so much of 
providing for his old age that he starves himself in youth 
and middle age. 

Saving and Inequality in Distribution. — In the twentieth 
century a new consideration has to be added ; wealth in the 
richest countries is so unevenly distributed, so much of it 
is concentrated in the hands of a few, that sometimes these 
few find it easier to save part of their income than to spend 
it all. The greatest fortunes are often made by men of un- 
educated tastes, who accumulate wealth, not for the sake 
of the wealth, but because their abihties lie in the direction 
of accumulating wealth ; they are ambitious only to be suc- 
cessful, and among their associates success is measured solely 
by the accumulation of wealth. They do not know how to 
use the wealth they have accumulated ; they never realize 
that it needs as much ability, though of a different kind, to 
spend money well as to make it; and having provided for 
themselves necessities and luxuries in excess of the most 
vulgar standards of ostentation, perhaps endowed a religious 
denomination or founded a university, they still have some of 
their income left and can only add it to their already burden- 
some capital. Saving with them is not " abstinence," but 
self-indulgence. Such persons are fortunately few, but as 
society gets richer, saving becomes possible for a larger 
number of people, and saving in larger amounts; the ac- 



Capital and lis Organization 97 

cumulation of capital, unless interrupted by war, revolu- 
tion, or misgovernment, proceeds like a snowball. 



HI 

Different Types of Organizatioft for Applying Capital 

The Individual Business. — A society's capital, however 
accumulated, cannot be used to the best advantage unless 
there are some means of getting it into the hands of the people 
who have organizing abiUty. How far do such means exist 
to-day ? So long as industry was simple, so long as the tools 
of manufacture cost no more than their user could earn in 
a few weeks, no special social machinery was needed for this 
purpose. The man who had the ability to run a business 
could usually be rehed on to save for himself all the capital 
he needed. This oldest of all methods of finding capital is 
still the most important. More businesses to-day are es- 
tablished by men who have saved enough to set up for them- 
selves than by any other means. Most of these businesses 
are small, but some of them serve as stepping-stones to some- 
thing bigger. As we have seen, there are still many fields in 
which large-scale enterprise has no overwhelming advantage 
over small. In retail trade, merchanting, and in some 
branches of the building trade, for example, it is possible for 
a man who possesses enterprise and sa\dng habits — rather 
a rare combination — to set up without aid from other people's 
capital. Even in manufacturing, wherever it is possible to 
rent room and power, the majority of firms are often firms 
of this simple type. A man with organizing ability and 
enterprise, having set up for himself, can attract attention and 
find " backers." If the " backer " decides to come into the 
firm as a partner, he may bring experience and ability into 
it as well as capital ; more usually the man of ability but no 
capital gets his opportunity by being taken into partnership 



98 Economics for the General Reader 

by his employer. Thus the partnership form removes many 
of the weaknesses of the private firm. It introduces new 
blood and provides more capital ; and it divides the work of 
management, which might in time be too much for a single 
man, without dividing responsibility. 

The great strength of the private firm is this union of 
interest and responsibility. The persons who have every- 
thing to gain or lose by the management of the business have 
that management entirely in their own hands. Their self- 
interest is an automatic check on waste and inefficiency. 
Moreover, centralized control saves a great deal of routine 
and red tape, and makes the business more mobile, quicker 
to act than any business managed by a committee. Hence 
it is the more suitable form of business for any enterprise 
in which risk-taking is an important element. The head of 
a private firm is likely to be more enterprising than the 
manager of a joint-stock company, because in case of failure 
he is answerable only to himself, and in case of success he 
takes the whole profit; Julius Caesar was always willing to 
risk everything on a pitched battle, because he was fighting 
for his own hand, while Pompey, with the Senatorial party 
dependent on him and " advising " him, dare take no risks ; 
the head of a business in a speculative trade requires very 
much the same quahties as a general. 

The Corporation. — Yet industry and commerce could 
never have reached their present scale if individual action 
had been the only means of assembling and mobilizing capital. 
Some businesses, such as railways and the supply of water, 
involve so large a capital outlay, and require the investor 
to wait so long for his return, that they would hardly attract 
individuals acting alone, even if individuals could find the 
necessary capital. Such undertakings can best be made by 
a number of people contributing each a part of the whole 
capital, in other words by a corporation. In other busi- 
nesses, such as banking and insurance, publicity, reputation, 



Capital and Its Organization 99 

and size are great aids to success, and a great corporation 
possesses these ; longevity is another great aid, and a company 
can outlive any individual, it need not be dependent on any 
one person and need not end with any one person's death. 
Having arisen to meet the case of enterprises for which it has 
peculiar advantages, the device of corporate enterprise has 
been applied continually to new fields of business, and new 
advantages have been discovered in it. This progress has 
been especially rapid since the principle of limited liability 
was made the basis of corporation. So long as the share- 
holders in a corporation were regarded by the law as 
partners merely, jointly and severally liable to the full 
extent of their whole resources to meet the debts of the 
company, this form of business could advance but little. 
The device of limiting liability removed the obstacle ; by 
complying with certain rules any group of persons of the 
required number can organize a limited liability corporation, 
in which the liability of each shareholder to meet the debts 
of the company is limited to the amount of his share ; if he 
holds only one $100 share and the company is unable to meet 
its creditors' claims on it, he is hable to lose his $100, but the 
creditors can claim nothing more from him. 

Corporate Securities. — The nature of a limited liability 
corporation or joint-stock company is exactly described by 
its name. The basis is a '' joint stock," the capital of the 
company being supplied by a number of people who hold 
" shares." Usually there are two or three classes of shares 
or stock. The Common Stock carries with it the control 
of the business, its holders take the profits and bear the losses ; 
the Bonds represent loans of capital made to the company, 
on the security of the company's property (which can be 
seized if interest is not paid) , receiving a fixed rate of interest 
which must be paid before any profits are declared, and carry- 
ing with them no share in the government of the company ; 
bondholders are creditors of the company, ordinary stockhold- 



loo Economics for the General Reader 

ers proprietors. Preferred Stock is an intermediate class, on 
which is paid not a rate of interest fluctuating with the earn- 
ings of the company, but a fixed rate. If the company does 
well, preferred stock receives no more than the fixed rate; 
if it does badly, the claim of the preferred stock ranks after 
the claim of bonds, and must be satisfied before any interest 
may be paid on the common stock. In case of liquidation, 
too. Preferred Stock usually gives a prior claim on the assets 
of the firm. Preferred Stock is either " cumulative," in 
which case any deficit in one year's interest on it must be paid 
out of succeeding year's revenue before dividends are paid on 
common stock ; or " non-cumulative," in which case the pre- 
ferred stockholder's preferential claim applies to each year sep- 
arately and is not carried forward from one year to another. 
Advantages of Corporate Form. — The company form 
makes possible the raising of capital for the very biggest 
enterprise. It enables the holder of small savings, who 
does not wish to use them in business himself, and who is 
not in close enough touch with business to intrust them to 
any private firm, to invest his savings remuneratively. It 
is equally useful to the holder of big savings, since it enables 
him to distribute his capital among many enterprises (and 
countries), and so avoid the risk of carrying all his eggs in 
one basket. Since shares in corporations are usually sal- 
able, the investor can realize his propertj^^ m a business with- 
out breaking the firm up ; if he were a partner in a private 
firm and wished to withdraw his capital, either he must 
find some other capitaHst to take his place in the business 
by buying his share, or he must risk breaking up the firm, 
since it might be unable to continue without his capital. 
The corporations provide another opening for men with 
organizing ability but no capital. As the amount of capital 
required to start in business increases, this alternative open- 
ing becomes more and more important; by no means, how- 
ever, does it provide the career open to talent, which the 



Capital and Its Organization loi 

efficient organization of industry, no less than justice, re- 
quires. " Influence" and nepotism are by no means confined 
to private firms ; it is a great advantage to any one employed 
in the higher branches of the railway service to be the son of 
a railway director. It is hard, however, to see how mere 
organization can overcome this evil ; in the most democratic 
of countries we find that lucrative and influential posts in 
the government service are filled almost exclusively from the 
so-called upper and middle classes ; democracy is a spirit, 
not a piece of governmental or economic machinery. 

Disadvantages of Corporate Form. — The corporation has 
its weaknesses as well as its advantages. It facilitates 
" absentee " capitalism, a much greater evil than absentee 
landlordism. The shareholders of a company may profit 
by iniquitous conditions of labor or the exploitation of de- 
fenseless natives without even suspecting their own re- 
sponsibility ; their ignorance does not excuse them, but a 
system that permits ignorance is a direct discouragement to 
honorable deahng between operative and employer. From 
the point of view of productive efficiency also the corporate 
system is defective. The management of a business by its 
owner provides an automatic check on inefficiency and waste 
inside the business, since the owner-manager bears all loss ; 
the corporate system removes this automatic check. The 
ownership and control of capital are separated ; the owner 
takes the profits and the controller only his salary. Attempts 
are being made to overcome this defect by giving managers 
a bonus on profits ; but it is difficult to restore that incentive 
to enterprise, that wilhngness to act in spite of the risk of 
failure when the chances of success are great, which the owner- 
ship of his business gives a man. The manager of a corpora- 
tion may be quite satisfied within himself that a certain course 
of action would pay, and yet be unable to explain or justify his 
belief before a committee of directors. It may be a case of 
" scrapping " good machinery on a big scale, or instituting a 



102 Economics for the General Reader 

new and expensive process, or pajang an unusually large 
salary to secure an unusually able subordinate, or changing 
the direction of the company's aims to a new class of goods, 
requiring expensive additions to and adaptations of machinery, 
or to a new market, requiring a big expenditure on advertis- 
ing and agents; to the manager, with his vivid perception 
of the future advantages of the action, the present cost may 
seem almost negligible, to the directors and shareholders 
the present cost — and present loss of dividends — may 
seem so great that they prefer to get a new manager. Against 
this we must set the dependence of the private firm on one 
or two individuals ; how often can one see a great firm, built 
up by the ability of a father, go down under the incompetent 
management of his sons or grandsons. A private firm, like 
an autocracy, is an efficient form of organization so long as 
its head is capable ; the corporation, the cooperative society, 
and the municipal undertaking probably get in the long 
run as good or a better average of ability. 

Special Applications of Corporate Form. — It should be 
remembered that the convenience of limited liability is so 
great that many businesses which are really private firms, 
controlled and owned by one man or a single family, have 
adopted the legal form of a limited liability company. An- 
other use of the joint-stock company is to enable an individ- 
ual or family to increase its capital without relinquishing its 
autocratic control of the business. There are many large 
businesses, the shares of which are very largely in the hands 
of one man or one family; all that that man or family has 
done has been to admit the pubUc into the business in the 
capacity of sleeping partner in order to get additional capital. 
This can be done most easily if the family or individual on 
floating the business keep in their hands all the common 
stock, letting the public take bonds. Or, again, a public 
company may get into the hands of a narrow circle of capi- 
talists who have purchased a majority of the shares. 



Capital and Its Organization 103 

Other Forms of Organization. — The other important 
organizations of capital or types of business we can deal with 
more briefly because they are described elsewhere in this book. 
In the cooperative undertaking capital is supplied by the 
consumers who receive the profits, not in proportion to their 
holding of shares, like the shareholders of an ordinary com- 
pany, but in proportion to their purchases. The great ad- 
vantage of the system is the stability given to the trade of 
the firm by the dividend on purchases. State and municipal 
enterprise are similar. A municipal street railway under- 
taking is a corporate enterprise in which the risks are borne, 
the management appointed, and the profits taken, by the 
taxpayers instead of by ordinary shareholders, while the 
capital embodied in the plant is supphed by private investors, 
who receive a fixed rate of interest secured by the revenues of 
the municipality, and are therefore very much in the same 
position as the bondholders of an ordinary corporation. 
The details of organization and management in a municipal 
undertaking and in a corporation are much the same ; the 
check on inefficiency is different ; in the one case society 
relies on the shareholders and directors to use their power to 
alter the management as soon as inefficient management 
diminishes their profits, in the other case the taxpayers have 
the management in their own hands and are relied on to check 
inefficiency in their own interests as both users and owners. 
The great difference between them, however, is a social or 
political, not an economic one ; the former is immediately 
under popular control through the machinery of representa- 
tive government, the latter is not. 

Limits of Corporate Enterprise. — Adam Smith has a sugges- 
tive section on the limits of corporate enterprise (Bk. v. ch. i.). 

The only trades which it seems possible for a joint-stock company to 
carry on successfully, without an exclusive privilege, are those of which 
all the operations are capable of being reduced to what is called a routine, 
or to such uniformity of method as admits of little or no variation. Of 



I04 Economics for the General Reader 

this kind is, first, the banking trade; secondly, the trade of insurance 
from fire, and from sea risk and capture in time of war; thirdly, the 
trade of making and maintaining a navigable cut or canal ; and, fourthly, 
the similar trade of bringing water for the supply of a great city. 

The subsequent development of corporate enterprise does 
not prove his principle to be unsound ; it does show that he 
unduly limited the number of cases it would cover. The 
great successes of corporate enterprise have been in the 
field of large-scale enterprise. Now large-scale enterprise 
can be conducted successfully in the long run only if it re- 
duces much of its practice to routine. Therefore to Adam 
Smith's instances we must add not only newer means of 
transport and newer developments of insurance and bank- 
ing, but a great deal of manufacturing. Where, as we have 
suggested, a private business has a great advantage over 
both the corporation and municipal enterprise is in taking 
the risks of a quickly moving market. Railways, insurance 
companies, street railways, water, gas, and electricity sup- 
plies, are not only capable of being reduced to routine ; they 
are capable of being reduced to routine just because they 
require no special marketing skill, because they are little 
troubled by foreign competition, fluctuating supplies of raw 
materials, the incursion of new firms into the market, and 
the fluctuations in demand due to changes in fashion and 
similar incalculable causes. Where, again, as it is so largely 
in the cotton industry, risk-taking is separated from the or- 
ganization of manufacture, the latter becomes a suitable 
field for corporate enterprise. It should be added that a 
great deal of routine work, small shopkeeping and farming, 
will never be taken over by corporate enterprise because the 
business is not worth the trouble and expense of forming and 
registering a company. 



Capital and Its Organization 105 

IV 

The Market for Capital 

Structure of Capital Market. — Is there a market for 
capital ? A business requires capital to start it ; and it re- 
quires frequent loans of capital to help it carry through its 
commercial transactions, and enable it to expand. For the 
latter purpose there is a highly organized market, the so- 
called " Money Market " ; consideration of this must be 
postponed until we examine our monetary and credit system 
at length ; for the former and more important purpose there 
is no definite market, but the beginnings of an organized 
market are to be seen in the methods of raising capital to 
start a new business. The commonest way of collecting the 
capital needed for a corporate enterprise is by advertisement, 
and by the circulation of a statement of the objects and needs 
of the company, called a prospectus. There is also a highly 
specialized class of " dealers " in capital, usually called 
" financiers," who have capital of their own and also control 
a great deal of other people's capital, and can therefore insure 
the subscription of sufficient capital to start a promising enter- 
prise, can in a word " float " a business. Similarly, promoters, 
stockbrokers, and others help to direct the flow of capital 
into the channel where it will give the best return. Invest- 
ment and trust companies afford perhaps the nearest ap- 
proach to an organized market for capital ; they undertake 
to invest their capital for people who feel they have not 
sufficient knowledge to do it for themselves. Insurance 
companies accumulate enormous funds which are available 
for safe investments. And wherever an industry is strongly 
localized, its prospects and possibilities, and the prospects 
and possibilities of firms and individuals in it, are probably 
sufficiently well known to make unnecessary any more special 
devices for bringing together the man with capital to invest 
and the man who can use capital. 



io6 Economics for the General Reader 

Stock Exchanges. — The Stock Exchange is sometimes 
spoken of as a " market for capital." That it is not ; the 
capital of a company has already been found and applied to 
the company's objects before its stock or shares appear in 
the Stock Exchange lists. The Stock Exchange is a market 
for the shares of companies that exist ; it facilitates the trans- 
ference, not of capital from one industry to another, but of 
shares of existing businesses from one owner to another. 
Indirectly, however, it is the means of guiding new capital 
into the industries in which it is most needed. By making 
shares readily salable, it encourages investment; and by 
registering the changes in value of shares in existing com- 
panies, it indicates where new capital is needed; if railway 
stock rises in value on the Stock Exchange, people with dis- 
posable capital are inclined to put it into new railways; if 
automobile stocks have fallen more than stocks in other 
industries, investors are warned not to put any more capital 
into the automobile industry. 



CHAPTER VI 
COMPETITION AND ASSOCIATION 

I 

The Pervasive Influence of Competition 

The Role of Choice. — Let us take our stand at the out- 
fitter's counter once more. We hesitate whether to buy a 
a woolen or a cotton shirt ; we might buy either, we shall 
not buy both. That means that the woolen industry competes 
with the cotton industry for our custom. We decided to 
buy a woolen shirt, and gave $2.50 for it. We could have 
got a cheap cotton shirt for seventy-five cents, and with the 
other $1.75 bought a book to present to friends. That 
means that the book trade competes with the woolen trade 
for our custom. Or we might have spent the $1.75 on a 
seat at a theater ; the theatrical trade then also competes 
with the woolen trade. The incomes even of the richest 
are limited ; we have to choose between the different things 
that are offered to us for purchase ; therefore the trades 
supplying these things are competing for our custom. 

Complicated Nature of Competition. — However, we spent 
our $2.50 on a woolen shirt. The outfitter at whose counter 
we stand is not the only man in the town who sells woolen 
shirts ; we might have gone to other shops ; there is compe- 
tition then among haberdashers for that portion of our in- 
come which we spend upon woolen shirts. The retailer 
who supplied us got the shirt from a jobber ; he might have 

107 



io8 Economics for the General Reader 

got it from some other jobber ; that is to say, jobbers compete 
for the custom of our retailer. The jobber bought his shirts 
from a shirt-maker ; there are many firms of shirt-makers, 
and they all compete for the jobber's custom. The shirt- 
maker bought the flannel, of which the shirt is made, from a 
manufacturer; he probably does not buy all the flannel 
he uses from the same manufacturer, and flannel manufac- 
turers compete for his custom. Similarly many spinners 
competed for the manufacturer's custom, niany wool dealers 
or growers for the spinner's custom. At every stage in the 
progress of the wool from raw wool to finished shirt there was 
competition for custom. Possibly two or three stages in the 
process of manufacture were under the same management; 
perhaps the manufacturer spun his own yarn, or the shirt- 
maker retailed his shirts to the public direct. But such 
" integration " only shuts out competition at one or two 
stages, it does not shut it out all along the line. A firm that 
controlled every process from the growing of the wool to 
the retailing of the shirt would still have to compete with 
other retailers. A trust that had control of the entire supply 
of some one article would have to meet the competition of 
substitutes and other commodities. In the unlikely case of 
a trust getting control of the entire supply of woolen shirts 
and putting up their price, we should buy cotton shirts ; in 
the impossible case of a trust getting control of the supply 
of shirts of all kinds, we could still wear knitted underwear. 

Scope of Gompetition. — We saw, however, that the woolen 
industry does not work in isolation. All the firms through 
whose hands the future shirt has passed on its way to the out- 
fitter's counter employ some transport agencies. Usually 
they have a choice of transport agencies ; that is to say, the 
various transport agencies compete for their custom. Pos- 
sibly two or three railways competed for the privilege of 
carrying the wool from the port to the spinner; or if there 
was no competition among railways, the railways had to face 



Competition and Association 109 

the possible competition of canal and motor-truck. Most 
of the firms used some machinery ; many machine-makers 
competed for their custom. They all used some sort of 
premises; many builders had competed for their custom 
when the premises were built. We need go no further back ; 
only remembering that steel of which instruments are made, 
and coal from which power is obtained, are needed all along 
the line, and are to be obtained from more than one source. 

One further step and this piece of our analysis is finished. 
At every stage in the making and moving of the shirt, the 
three agents of production — land, labor, and capital — 
were used. Hence at every stage there were landowners, 
capitalists, and workers competing for employment. Each 
class competed with the other classes ; the manufacturer, 
for instance, might hesitate between capital in the form of 
labor-saving machinery and labor, between capital in the 
form of more perfect machinery and the products of land 
in the form of better raw material. And the members of 
each class compete with one another ; landowners offer 
competing sites, laborers offer their labor, and capitalists 
their capital against one another. 

Thus at every stage in the making of the shirt and all 
along the line there is competition for custom, competing 
ofifers to supply. The buyer has a choice. The inducements 
which the sellers offer to the buyers to give them custom 
vary. The most obvious is to offer the same article at a 
lower price than competitors ; but that is not the only in- 
ducement. The seller may offer a better article at the same 
price ; or he may offer the same article in a more attractive 
wrapper ; or he may advertise his article and so create in the 
buyer's mind, without the buyer being conscious of it, an 
opinion that his article is a superior article ; or he may employ 
a persuasive agent, or a traveler who is a Free Mason or 
member of the "B. P. O. E." and therefore acceptable to 
buyers who are also Masons or "Elks" ; or he may offer some 



no Economics for the General Reader 

brand or patent or specialty which certain users insist on hav- 
ing. There are many ways in which sellers seek to induce 
buyers to prefer their goods to those of other sellers. They 
may even make no attempt at all, and leave the buyers to 
decide without any inducement ; but so long as the buyers 
have a choice, what the economist means by " competition " 
exists ; the buyer is not restricted to one source of supply. 

Competition in Buying. — Competition works also the 
other way. Just as there is competition to sell, so there is 
usually competition to buy; competition to buy is Just as 
general as competition to sell. We are not the only people 
who want shirts, and, if we will not pay the outfitter's price, 
he will keep his shirt for some other customer. Our out- 
fitter is not the only man who wants shirts to stock his shop, 
and he has to compete with other retailers for the stocks of 
the wholesalers. Similarly the jobbers are dependent on 
the shirt-makers, who can play off one jobber against another. 
The shirt-makers compete with one another for the manu- 
facturer's stock of flannel. The manufacturer competes 
with other manufacturers for yarn; the spinners compete 
among themselves for wool. All the firms engaged in manu- 
facture compete with one another for the necessary machines, 
and the machine-makers with one another for suppHes of 
steel. All of them are competing for the use of transport 
agencies and for coal. And every firm wants labor, wants 
capital, and wants land ; and since the suppHes of labor, 
capital, and land are limited, there is competition to buy 
them. 

Thus, to generalize from our humble example, a society 
which employs the division of labor is a competitive society, 
using " competition " in the broadest possible sense with- 
out any suggestion of good or evil. Throughout industry 
we see on the one hand competition among sellers for custom, 
and on the other hand competition among buyers for goods 
and services. 



Competition and Association iii 

Competition and Price. — The competition of buyers tends 
to keep prices up, the competition of sellers to send them down. 
Normally the pressure of competition among sellers is stronger 
than that among buyers. The seller has his article to sell, 
and must get rid of it ; the buyer is not yet committed to 
anything — he may decide to buy a substitute or devote his 
money to some other object altogether. But all alike are 
subject to some pressure of competition — none can afford 
to forget that he is not alone. The seller must remember 
that if he will not sell, his customer can go elsewhere ; the 
buyer, that if he will not pay the price, there are others who 
may. Even where a single process, or the supply of some 
material, or even an entire trade, may be monopolized, the 
monopolist would not have freed himself from all pressure 
of competition. He would still have to compete with other 
trades for labor and materials, with other goods for the 
custom of the public. Even the different departments of 
the same public authority compete, for example the gas and 
electric light authorities of the same municipality under 
municipal ownership of these utilities. Competition in the 
present economic system is like a head of water ; we can build 
our weirs and embankments and they will give us a respite 
from its pressure, but its force has not been abolished. 

II 

Conflicting and Common Interests Arising from Competition 

Competition and Association. — What effect has this pres- 
sure of competition on the relations of the firms and indi- 
viduals that make up the business community? We can 
usually trace the effect of any continuous pressure in the 
structure of a body ; we can do so in this case in the structure 
of economic society. Competition gives rise to a series of 
conflicting interests and a series of common interests among 



112 Economics for the General Reader 

individual firms. The conflicting interests lead them to 
stand alone, the common interests lead them to associate. 
Thus, according as we look at it from the point of view of 
the conflicting or the common interests, we shall see society 
as an assembly of competing or an assembly of associated 
units. 

The Conflicting Interests. — The different trades compete 
forward for society's income, backward for the agents of 
production and the services of the transport, power, and 
implement industries. What one has, another cannot have. 
Districts and countries compete for custom — for the market, 
as we say — and for raw materials and other requisites of 
production. In each trade, at each stage, the different 
firms compete, each anxious to get as big a share of the whole 
trade as possible, each anxious to get its materials and the 
means of production specialized to its business as cheaply as 
possible. The individuals of society compete with one 
another in two capacities; they compete as consumers and 
they compete as producers. As consumers they could all 
probably do with more than they get; they would all cer- 
tainly prefer to pay for their goods the lower price at which 
they could get them if they were the only customers for 
them. Similarly they compete as producers ; each has some 
labor to sell, or else the use of some land or capital. The 
price each can gets depends on the price that other people 
will accept for their labor, land, and capital. Thus every- 
where we find the conflicting interests which we commonly 
associate with the word " competition," and, because this 
conflict of interests is so obvious, we are inclined to forget 
or ignore the correlative community of interests which this 
conflict creates. 

Community of Interests. — How does competition create 
a community of interests? It does so by its influence on 
prices. Competition to sell tends to force prices down, 
competition to buy tends to force prices up. The mere 



Competition and Association 113 

existence of an alternative seller is a check on the power of 
any seller to exact the price he would b'ke ; the mere exist- 
ence of an alternative buyer is a check on the power of any 
buyer to buy as cheap as he would like. The worker's in- 
come depends on selling labor at a high price and buying 
commodities and services at a low price ; it is the competi- 
tion of other workers that keeps down the price he can get 
for his labor, the competition of other consumers that keeps 
up the price of commodities and services. Similarly with 
landowner and capitalist ; it is the competition of other 
landowners and capitalists that hampers their efforts to get a 
higher price for the use of their land or capital. So with in- 
dustries ; the competition of other industries is the check 
on the prices they can charge ; at the same time it is the check 
on their power to beat down the other trades, the workers, 
the capitalists, the landowners, from whom they buy ma- 
terials and aids to production, labor, capital, and land. In- 
side any one industry, it is the competition of other firms 
which hampers each firm in its efforts to sell its products 
dear and to buy its labor and its materials cheap. The 
members of each economic group or class, therefore, while 
their interests conflict within the group or class, have a 
common interest in relation to other groups or classes. They 
have a common interest in keeping up the selling price of 
the commodity or service which the group has to sell, and in 
keeping down the buying price of the commodities and 
services which the group buys. All incomes depend on suc- 
cess in selling dear and buying cheap ; competition, the exist- 
ence of an alternative seller or buyer, is the obstacle to suc- 
cess. The members of each economic group or class there- 
fore have a common interest in extinguishing or restricting 
competition within the group or class. 

Conflict and Community of Interest. — Thus we get the 
common interest of all the traders in one district as against 
traders of another district ; Free Traders and Protectionists 



114 Economics for the General Reader 

agree as to the desirability of getting as much trade for their 
own country as possible, they differ only as to the means ; and 
as all the citizens of a country have a common interest in 
that country's prosperity, so have all the members of a town 
or industrial district in the prosperity of that town or dis- 
trict. So too we get *" the interest of the trade." All the 
persons connected with the cotton industry have a common 
interest in inducing the public to prefer cotton to woolen 
shirts ; within the boundaries of the trade they may quarrel 
among themselves as to the disposal of the price of the shirts, 
but they are united in their hostility to wool and linen ; 
they all, from the humblest operative to the biggest manu- 
facturer, stand to gain by a growth in the demand for cotton 
goods. Within each trade again, while there is conflict 
between the different firms at each stage, the stages have 
each a common interest which will sometimes serve as a 
basis for common action. Manufacturers all agree that 
retailers get more than their fair share of the profits of an 
industry, and they will act together to prevent their exac- 
tions ; the retailers, on the other hand, will form retailers' 
defense leagues to protect themselves against the exactions 
of manufacturers. All the firms at each stage of a manu- 
facturing process have a common interest in getting as cheap 
as possible what they take from the preceding stage and 
in selling their work as dear as possible to the succeeding 
stage. To come to individual firms, while employer and 
employed do not always constitute a happy family, they 
have some interests in common. The employer wants as 
big a share of the trade as possible, and his employees stand 
to gain if he succeeds. They may get no bigger wages than 
they would get if the firm were unsuccessful, but they gain 
something in regularity and security of employment. And 
when we come back to the final agents of production — 
land, labor, and capital — while landowners compete with 
one another, laborers with one another, and capitalists with 



Competition and Association 115 

one another, no one who is interested in politics is likely to 
forget that there is a " landed interest," a " capitalist in- 
terest," and a " labor interest." 

Thus everybody in our present economic society stands 
in two relations to the other members of society, in a relation 
of conflicting and in a relation of common interest. Both 
these relations spring from the same cause — the prevalence 
of what, for want of a better word, we call " competition." 
Competition tends to force us to struggle, fight, conflict 
with our neighbors ; the desire to relieve ourselves from 
the pressure of competition compels us to combine, associate, 
cooperate with our neighbors. We associate with our 
competitors in one economic group, in order to compete 
more effectively with other groups. 



Ill 

Combination and Trade- Unionism; the Cooperative Movement 
and Municipal and National Trading 

Purposes of Combination. — A common interest leads 
people to associate ; what are the chief forms of association 
in the present economic system? We have seen that com- 
petition takes two forms, competition to sell and competi- 
tion to buy. We can best consider the chief forms of associa- 
tion under these two heads, associations to escape the pressure 
of competition in selling and associations to escape the pressure 
of competition in buying. 

Restricting Competition in Selling. — Associations to re- 
strict competition in selling have attracted most attention, 
and we shall return to them in the next two chapters. The 
most important of them are the combinations among firms 
in the same trade in trusts, cartels, pools, and price-agree- 
ments, and the combination of workers with the same kind 
of skill in trade unions. Sellers always have acted together 



ii6 Economics for the General Reader 

in fixing prices; never have they competed quite freely. 
Such phrases as " the custom of the trade," a " fair price, 
" cut-throat competition," " bad for the trade," indicate 
that sellers in every trade agree informally and perhaps 
unconsciously that there are limits to their freedom of ac- 
tion, that " the trade " has a claim on their loyalty and 
consideration, because " the trade " represents an interest 
which they have in common with their competitors. Before 
the Industrial Revolution this common interest was often 
expressed in corporate form, in gilds and companies, or 
formulated by authority in statutory prices and qualities. 
In the last generation it has again become expUcit ; all sorts 
of combinations, from temporary price-agreements to com- 
plete amalgamations, have been formed. Where the law 
will enforce such a contract, contracts have been entered 
into by former competitors to observe common price lists 
and selling rules, as has been done in Germany; where the 
law would not enforce such a contract, as in England and the 
United States, secret agreements or out-and-out amalgama- 
tions have been substituted. Any combination gives a 
respite from the pressure of competition, no combination 
aboHshes competition. The most successful monopolist has 
to compete with substitutes, with other trades for society's 
income, and with other trades for materials and land, labor, 
and capital. A very small restriction on competition, how- 
ever, may be sufficient to make a very large fortune. 

Trade Unions. — Trade unions are associations of sellers 
who have a particular kind of labor to sell. Since they have 
usually nothing else to depend on, these associations are 
peculiarly important to their members, and in England are 
given a privileged legal position. They are the most obvious 
case of the stress of competition forcing people into coopera- 
tion or combination. Just as capitalists with a specialized 
kind of capital try to combine and get a monopoly of that 
kind of capital, so laborers with a specialized skill try to 



Competition and Association 117 

combine and get a monopoly of that kind of skill. In neither 
case, however, as we shall see later, does the monopoly con- 
stitute the only, or even the chief, advantage of combina- 
tion. The " interest of the trade " and the " interest of labor " 
are not confined to the attempt to secure a monopoly price. 

Restricting Competition in Buying. — Important as are as- 
sociations to restrict competition in selling, they are probably 
less important, less successful, and less general than the 
associations which have for their object the restriction of 
competition in buying, or which are based on the common 
interest of the members of a group as buyers. Consumers, 
as a class, have a common interest, which is responsible for 
many forms of association ; and the " competing " members 
of every trade have a common interest as buyers, which pro- 
duces much more stable associations than their combinations 
to sell. The one form of consumers' association which has 
not attracted in the United States the attention it deserves 
is the cooperative movement, an association of consumers for 
the cooperative purchase of common articles. The cooperative 
stores of Great Britain have a membership of about three 
milUon and an annual trade of almost $800,000,000. The 
loyalty and continued custom of this great mass of consumers 
is secured by distributing among them the profits — or 
rather the difference between cost price and selling price — 
in the form of dividend in proportion to purchases. Idealists 
often lament the importance which cooperators attach to 
the " divi " — rightly, if the " divi " leads cooperators to 
forget their ideals ; but we must remember that the device 
of dividend on purchases is one of the great social inven- 
tions of the nineteenth century, great because it enlists for 
an idealist movement the loyal support of people who are 
susceptible only to a materialist appeal. 

Types of Cooperation. — In England, where the coopera- 
tive movement has developed farthest, the cooperative store 
is the best known of the associations of consumers, but not 



ii8 Economics for the General Reader 

the biggest. The friendly societies have a far bigger mem- 
bership, and are merely associations of consumers to buy 
medical service and insurance against sickness. The clubs, 
of which English society in every grade is proUfic, are the same 
in principle ; when Englishmen wish to play golf or cricket 
or football, they associate to rent and adapt fields and pur- 
chase implements; they get billiards and cards in the same 
way, and the Christmas goose club is only another applica- 
tion of the same method. The English working-classes are 
cooperative to the backbone, if by cooperation is meant the 
association of consumers ; whatever they care most about, 
they prefer to get by associating with others to buy it 
collectively. In the United States clubs of various kinds, 
lodges, etc., are also common, but the cooperative spirit of 
the mass of people is much less highly developed than is 
that of the English public. 

Agricultural Cooperation. — The term "cooperation " is used 
to describe another form of buyer's association, which is 
less common in England and America than on the Continent. 
The independent and competing peasant farmers of Den- 
mark require certain expensive machinery to turn their 
milk into butter. If they acted independently, since they 
could not afford to buy machinery, they would have to sell 
their milk to a large firm that could, or pay some such firm 
a commission for the use of machinery, as English farmers 
pay for the hire of steam-plows. They prefer to act co- 
operatively. The " competitors " combine to purchase and 
manage the dairy plant, all send their milk to it, and each is 
credited with a proportion of the output corresponding to 
the milk he sends ; any profit (or loss) is distributed among 
the members in proportion to the use they make of the plant. 
The principle is exactly the same as that of the cooperative 
store, except that the members are not heads of families 
buying for their own consumption, but heads of businesses 
buying for the purposes of their businesses. Having set 



Competition and Association 119 

up their cooperative society, they can use it for other pur- 
poses, and the cooperative dairy is used to secure marketing 
facilities and for the purchase of manures, stock, and imple- 
ments. By cooperating in this way the Danish peasants 
have been able to compete more effectively with the farmers 
of other countries. The English farmer, with an industrial 
population at his doors, has been able to turn from grains 
to meat and from meat to milk as foreign competition pressed 
on him, and is only now finding it necessary to cooperate in 
order to compete effectively. Among German small farmers, 
the place of the cooperative dairy is taken by the cooperative 
bank. None of them has enough capital to work his farm 
to the best advantage. Acting independently, they would 
have to go to the money lender and pay dear for their loans. 
So they combine and form a stock of capital by contributing 
each a little, and loan this out among the members. They 
are competitors in the sale of the product, they associate 
to get the means to raise that product. 

Employers' Associations. — Less obvious applications of the 
same principle — the association of competing businesses to 
obtain some requisite of the business otherwise unobtainable, 
or to restrict competition in buying some requisite — are to 
be found in great industry conducted on capitalistic prin- 
ciples. Just as the trade union is an association of work- 
people to restrict competition in the sale of labor, so employers' 
associations and federations are primarily associations to re- 
strict competition in the buying of labor. While employers 
are competitors in the sale of the product, they associate to 
get the means to raise that product. Their associations 
may serve other purposes, such as watching the interests 
of the trade before state and national legislatures — an 
extremely important work in a protectiom'st country, where 
a new tariff may make or mar an industry — and advertising 
its products. Competing banks associate to maintain the 
clearing house, without which they could hardly carry on 



I20 Economics for the General Reader 

their work ; fire insurance companies pool their statistics, and 
reinsure with one another to prevent and distribute losses. 
Competing newspapers combine to set up press associations 
for the collecting of news, and, it is said, in one instance to 
finance the defense in a "spicy" murder case. The special- 
ized market or exchange and the representation to the public 
of a localized trade's needs and claims through the chamber 
of commerce are secured in the same way by cooperative 
action. 

The parallelism of the commercial method of supplying 
a want, by independent purchase, and the cooperative method, 
by association of consumers, may be illustrated by a case, 
common both in England and the United States, which em- 
bodies both methods — or neither. It is common for a club 
in England and the United States to be organized as a cor- 
poration with transferable shares which may earn a profit. 
If this is done merely for convenience of administration, and 
the dividend on the shares is limited to 4 per cent or 5 per 
cent, we could regard the club as a cooperative institution; 
if, on the other hand, it is run primarily for profit, as many 
clubs are, we should regard it as a purely commercial under- 
taking in spite of its cooperative appearance. 

Public ownership. — • There remains for consideration an 
important type of association of consumers for cooperative 
purchase, namely the use of the machinery of representative 
government for some general economic object. Municipal 
and national ownership or " trading," as it is called in Eng- 
land, looked at from the point of view of economic structure, 
are another case of the association of consumers, and present 
a very close parallel to the two sections of the cooperative 
movement proper which have been described. Certain 
commodities of very general consumption — gas, water, 
electricity, street railway service — may be owned and con- 
trolled by the municipality. Since the municipality is simply 
the consumers in their political capacity we may say that 



Competition and Association 121 

municipal ownership is cooperative ownership. So far as the 
consumers and the taxpayers do not coincide, so that profits 
made out of the consumers and distributed in relief of taxes 
are not being paid back to the consumers, the cooperative 
principle is being infringed. It should be noticed that these 
services are almost all from their technical nature monopolies. 

Public Aid and Advertising. — The other class of municipal 
ownership corresponds to the other type of voluntary cooper- 
ative organization, of which the cooperative dairy or credit 
bank are typical. It is the use of the machinery of represen- 
tative government to aid the citizens in their capacity as 
business men, not as private consumers. Bradford, the 
center of the English woolen and worsted industry, maintains 
a conditioning house for testing wool ; in Roubaix, the French 
woolen center, the chief conditioning house is maintained 
by the Chamber of Commerce. The Bradford Corporation 
went for its water many miles farther than it otherwise need 
have done, because it must have soft water for wool scouring 
and dyeing ; and it has decided to subsidize the Midland 
Railway Company, to induce it to bring its main line through 
the town, on the ground that a main through line will benefit 
the trade of the city. The city of Cincinnati built a railroad 
into the South to develop its Southern trade. Similarly 
watering-places maintain municipal baths, seaside board 
walks, municipal concert halls and bands, and spend large 
sums on municipal advertising in order to aid the taxpayers 
in the chief business of the town, boarding-house and hotel 
keeping. So far from superseding private enterprise, these 
municipal undertakings are carried on to aid private enter- 
prise. 

Association, then, or cooperation, is as common in the 
present organization of industry as is competition. The 
description of the present organization as " the present 
competitive system " is justified by the reliance which the 
community places on competition to insure an equitable 



122 Economics for the General Reader 

distribution of wealth, and we shall consider competition 
from this point of view in a later chapter. But the common 
sharp opposition of competition and cooperation is mis- 
leading, since competition is constantly inducing members 
of the same economic group or class to associate or co- 
operate, and much cooperative organization is for the 
object of enabling the members to compete more effectively. 
Competition and cooperation represent opposite motives ; 
but the opposite of " competitive " in the phrase " com- 
petitive system " is " bureaucratic^", 



CHAPTER VII 

MONOPOLY AND COMBINATION 

I 

In Certain Industries Economy and Efficiency Can Be 
Secured Only by Monopolistic Control 

In the last chapter we saw that different classes of buyerSj 
impelled by a common interest, formed different kinds of 
cooperative associations for buying. Similarly, we saw, the 
sellers of a commodity have a common interest in keeping 
the price of that commodity high, and this common interest 
leads them to associate or combine. Hence we get in modern 
industry cases of monopoly and a strong tendency in the 
direction of monopoly. 

Definition of Monopoly. — An industry is said to be monop- 
olized when the supply of its products or services is under 
the control of a single selling agency. This agency may be a 
single firm, which has in its own hands the entire industry; 
but there may be many firms in the industry and yet monop- 
oly may exist, provided that the firms all act together as 
one agent for purposes of selling. MonopoUes fall into two 
classes : in the one class the monopoly is the outcome of 
technical considerations which make it impossible without 
great waste for more than one firm in each market to engage 
in the industry ; in the other class technical considerations 
impose no such restriction on the number of firms that can 
engage in the industry, and the monopoly is due to com- 
bination between firms which previously competed. In the 

123 



124 Economics for the General Reader 

first class monopoly is usually complete and permanent; 
in the second it is seldom complete and seldom permanent; 
but even when the attempt to secure monopoly fails, it 
leads to important modifications in the structure of industry. 

Public Utility Monopolies. — The chief industries that 
fall within the first class are the supply of water, gas, and 
electricity ; street railways ; and postal, telegraph, and 
telephone services. If railways may be taken as belonging 
to this type, then perhaps a quarter of the capital of the 
United States is invested in these industries. The chief 
characteristic of them all is that they are tied down by the 
nature of their equipment and organization to serving the 
particular market in which they are situated. This is so, 
because the products of the gas, water, and electric light 
industries, and the services of the other industries mentioned, 
are distributed and delivered to the consumer not by the 
ordinary means of transport, but by specialized means form- 
ing an important part of the " plant " or fixed capital of the 
industry. A gas or water company can supply only the dis- 
trict served by its pipe lines, a street railway company only 
the districts reached by its lines, a telephone company only 
the persons connected by wire with its exchanges. But if 
these companies have their market restricted, they have it to 
themselves. Water, gas, and electricity can be supplied 
cheaply only to consumers connected with the supply pipe or 
cable ; and, since it is obviously impossible to have two sets 
of gas mains, water mains, and cables down every street, the 
firm with which a consumer is connected has a monopoly of 
that consumer's custom. 

The case of the industries which maintain communica- 
tions is similar ; though their monopoly is not quite so secure, 
their market is still " protected " by influences more potent 
than any tariff. Telegraph and telephone systems, postal 
service organizations, even street railway systems, can be 
duplicated at less expense than systems of water mains and 



Monopoly and Combination 125 

gas mains ; but duplication impairs the efficiency of the 
service. To duplicate water mains would not impair the 
quality of the water, but a telephone system is efficient only 
when it has a monopoly. Any system of communication to 
do its work properly must include all the people who wish to 
communicate ; if the telephone subscribers in a district are 
divided between two competing telephone companies, then 
the subscribers of neither will have access to all the people on 
the telephone in the district. Competition between different 
telephone companies, different telegraph companies, or different 
postal services serving the same area is possible only by com- 
pletely duplicating plant and organization, and, since the 
number of possible customers — the " market " for the 
service — cannot increase correspondingly, such duplication 
can never pay, and is not likely to be lasting. If it were not 
already appropriated to another purpose, the term " localized 
industries " would describe this first class of monopolies. 
They can serve only the locality in which they are situated, 
and they are open to no competition from outside the locality ; 
within the locality competition is excluded, in the case of 
gas, water, and electric light and street railways, by the method 
of distributing the goods or services suppUed, in the case of 
the communication industries by the nature of the service 
rendered. 

Economy of Monopoly. — It will be noticed that all these 
industries, except the Post Office, require an initial expenditure 
of capital which is very large in proportion to annual working 
expenses. The plant in every case is expensive, but econom- 
ical ; it costs a great deal to construct, but cheapens the 
service to such an extent that competition is possible only from 
firms with a similar plant ; the cost of supplying water, for 
example, is almost negligible, once reservoirs are constructed 
and pipe lines laid. Hence a large proportion of the income 
from fees and charges goes in payment of interest on the capital 
required for this initial expenditure ; if working expenses only 



126 Economics for the General Reader 

had to be met, great reductions could be made in the charges 
made to consumers. The working expenses again are very 
largely fixed and independent of the number of persons served 
or the amount of service rendered. The cost of running a 
trolley car is practically the same whether one passenger or 
forty travel in it ; the motorman and conductor must be paid, 
motor power supplied, track kept in repair, and management 
expenses met. Hence the cost of production per unit of 
service falls rapidly as the number of persons served increases, 
while a reduction in the output or use of the plant brings with 
it a less than proportionate reduction in expenses or cost 
of production. In these industries, therefore, unrestricted 
competition means inevitable ruin to the weaker competitor, 
and usually loss of all profit to the stronger. Prices or rates 
will be reduced until they are barely suflScient to cover the 
working expenses of the weaker firm and give no surplus 
to pay interest on its capital ; the stronger firm (as a rule the 
larger) has lower working expenses per unit of service and 
can cut prices still further; as it steals its competitor's 
customers, its costs fall still further, and therefore its power 
to cut prices without actual loss is increased; by cutting 
it ruins its competitor, but only at the expense of sacrificing 
all profit itself. There is not the possibility in these in- 
dustries that there is in other industries and in agriculture 
of extending the market indefinitely by reducing prices. 
The market is limited to the population reached by the 
plant and organization of the competing firms. Once this 
population is supplied, prices can be cut only at the expense 
of the profits of the competitors. 

Competition, therefore, in the case of the localized services 
which we are considering, is difficult, wasteful, and futile: 
difficult because it is only possible by duplicating an expen- 
sive organization for a limited market ; wasteful, because the 
services can be supplied at their theoretically lowest cost only 
if the whole market is served by a single plant or organization, 



Monopoly and Combination 127 

and in the case of communications, because efficiency is secured 
only by one system covering the whole market ; futile, be- 
cause the superiority of the stronger competitor is increased 
by competition, so that competition must result in the estab- 
lishment of monopoly by the ruin or retirement of the weaker 
competitors. 

II 

Railways May Be Classed with These Industries 

Railways as Monopolies. — Railways may be regarded as 
belonging to this type. It is true that competition between 
railways occurs and is not so wasteful as competition in the 
supply of gas, electricity, or street railway services. Different 
companies may offer alternative routes between the same 
terminal points and compete for the traffic between these 
points ; and the duplication of plant which this competition 
involves is not wasteful, provided that the railways serve 
different districts en route. Still, complete efficiency requires 
one, and only one, system in each geographical area ; and if the 
parts of the system are under the control of different 
authorities, complete efficiency will be attained only by the 
different authorities working together as if the whole system 
were the monopoly of a single authority. Railways are means 
of communication ; the greater the area (or population) 
to which a railway gives access, the greater is the service 
rendered. Hence in countries where the railways have 
been constructed piecemeal by different companies, clearing 
houses were early established to facilitate this inevitable 
cooperation ; the cases which have been known of competing 
companies, instead of dovetailing services, running trains 
between the same points at the same times, or arranging 
their trains so that they just do not connect with those 
of another company, are merely examples of the inefficiency 
due to divided control. 



128 Economics for the General Reader 

Competition Self-destructive. — Again, competition tends 
to disappear. If two railways begin rate-cutting against 
each other, the struggle can only end, unless it is ended earlier 
by agreement, in the ruin of the weaker. The stronger 
competitor is the company that can cut rates lowest without 
actual loss ; by cutting rates it attracts traffic from its opponent 
to itself. This increase of traffic increases its margin of 
superiority, since this additional traffic does not involve a 
proportionate increase in working expenses, while the reduction 
in traffic which its opponent undergoes does not bring with it 
a proportionate reduction in expenses ; about 80 per cent of 
the expenses of a railway are fixed independently of the amount 
of traffic handled — permanent way and stations have to be 
staffed and maintained whether much or little traffic passes. 
But though the stronger competitor can be sure to ruin the 
weaker, it does it at the sacrifice of its own profits. The 
working expenses of a railway are small in proportion to its 
capital; receipts must exceed expenses by something like a 
half, as a rule, if 3 or 4 per cent interest is to be paid on the 
capital embodied in the railway ; a reduction on the receipts, 
therefore, of one-third will not reduce the dividend by one- 
third only, it will make it impossible to pay any dividend at 
all. Suppose that a railway has a capital of $50,000,000, its 
annual receipts $7,000,000, its annual expenses $4,000,000 ; the 
excess of income over expenses enables it to pay a dividend 
of 6 per cent on an average on its shares. Another railway is 
constructed, at a cost, say, of $50,000,000, and succeeds by 
cutting rates in attracting to itself half the available traffic. 
The expense to each railway of dealing with half the traffic 
will not be half of $4,000,000, it will probably be at least 
$3>500j000 j the receipts of each railway will be only $3,500,- 
000, since the two railways are now sharing the $7, 000,000 's 
work of traffic which the one had before. The result is that 
each meets bare expenses and pays no dividend ; whereas, 
when one railway undertook the whole traffic with a capital 



Monopoly and Combination 129 

of $50,000,000, it was able to pay 6 per cent on that capital, 
now that two railways with a joint capital of $100,000,000 
share the work, no interest is paid at all. Now, the users of 
the railways gain something by the reduction in rates {so 
long as the rate war continues) ; but this gain is hardly likely 
to balance the social loss involved in applying $50,000,000 
new capital and increasing working expenses from $4,000,000 
to $7,000,000 to afford facilities for an increase in traffic 
which could have been afforded quite as well by a slight exten- 
sion of the original railway and a slight addition to its expenses. 
Hence railway history in the United States and Great Britain 
is a history of amalgamations and absorptions, and of confer- 
ences and agreements, legal or illegal, to prevent rate-cutting. 
The effect of these agreements is not necessarily to abolish 
competition, but rather to substitute for competition in rates 
competition in facilities ; but such agreements lead in many 
cases to a pooling of the entire traffic over competing lines, 
which is the abolition of competition. 

Railway systems, then, like street railway systems or water 
supplies, tend to become monopolies. They have the char- 
acteristics of the locaUzed services : large initial expenditure 
on plant and organization, working expenses largely in- 
dependent of the number of persons served and amount of 
service given, a market restricted to the area in which the 
plant lies, and a practical monopoly of that market ; com- 
petition is wasteful and ineffective, unified management and 
control are required by technical considerations to secure effi- 
ciency and economy of service. 

Ill 

Methods of Social Control of These Industries 

Methods of Regulation. — The existence of important 
industries in which monopoly is a technical necessity intro- 

K 



130 Economics for the General Reader 

duces into the relations of the State to industry a complication 
unperceived by the early advocates of laissez-faire. What 
may be called the normal relation of the modern State to 
industry is indicated in the description often given to modern 
industry, " the present competitive system." The modern 
State does not as a rule undertake to supply its members with 
their economic necessities ; it leaves this work to the free 
enterprise of private individuals. To protect its members 
from abuse under this system of free enterprise — consumers 
from extortion and producers from underpayment — it 
relies primarily and normally on competition. It assumes 
that producers will be able to get fair payment by playing off 
one buyer against another, and that consumers will be able 
to get goods of satisfactory quality at a price somewhere 
near cost of production by playing off one seller against 
another. This is the general principle; but in the case of 
the industries we are considering the consumer is deprived 
of the protection of competition ; there is no competing seller 
to whom he can appeal, if the first he applies to supplies an 
inferior article or charges an unfair price. The State, there- 
fore, is faced with a new problem : if it continues to rely on and 
to foster competition, it encourages waste and inefficiency, 
and leaves the consumer at the mercy of the monopolist; 
if it departs from its usual principle it has to discover some 
other method of controlling industry in the interests of the 
consumer. In the United Kingdom and on the continent 
of Europe the necessity of monopoly, coupled with some 
special form of control, has usually been accepted, differences 
have arisen only as to the form which control is to take; 
in the United States there has been a much greater reluctance 
to depart from the principle of free enterprise, and attempts 
have constantly been made to stimulate and support com- 
petition. The influence of technical considerations, however, 
in promoting monopoly, and still more the fact that com- 
petition is self-destructive, have proved too strong for such 



Monopoly and Combination 131 

attempts, and even in the United States the policy of granting 
unlimited and unconditional "franchises" to gas, water, and 
street railway companies is coming to an end. 

Function of the "Franchise." — These industries all in- 
volve a considerable disturbance of private property in the 
construction of their equipment ; to acquire the compulsory 
powers, which such disturbance needs, they have to apply to 
the State ; this application gives the State the opportunity 
of imposing conditions and exercising control. The permission 
to engage in any of these industries is usually embodied in a 
private Act of the Legislature or a " concession " or " fran- 
chise " from a local government authority. The State 
assumes that the monopoly is its property when it grants the 
company permission to engage in the industry. The grant 
transforms a tendency into a fact; technical considerations 
gave the industry a tendency in the direction of monopoly, 
the intervention of the State gives the monopoly legal sanc- 
tion. With the grant are coupled the conditions which have 
for their object the protection of the consumer. 

Limitation of Profit. — The simplest form of control is for the 
State to limit the rate of profit. The rate of interest which 
the company may pay on its share capital is fixed ; any excess 
of earnings above that figure goes to the State (as in the 
case of certain French and American railways) or to the con- 
sumers in the form of reduced charges (as in the case of certain 
English gas companies and of some American public utility 
corporations) . This method of control has two great defects ; 
the rate of profit depends not on charges, but on capitahzation 
on the one hand, and on eflficiency of management on the other. 
It is possible for the concessionaries, by capitalizing the com- 
pany at a high enough figure, to pocket the whole value of the 
monopoly in a lump sum, after which excessive charges will 
only pay a moderate rate of dividend. On the other hand, 
efficient management may by preventing waste and improving 
organization earn sufficient profit to pay a high rate of interest 



132 Economics for the General Reader 

on a moderate capitalization without excessive charges; in 
which case to limit the rate of profit is to penalize efficient 
management without in any way benefiting the consumer. 
Instead of limiting the rate of profit the State may limit the 
charges which the company may make. The charges which 
Enghsh railways may make are limited by the Acts of Par- 
liament constituting them; and since 1894 they have been 
allowed to raise rates only with the permission of a special 
court, the Railway and Canal Commission. Similarly in the 
United States railway rates have been under the jurisdiction 
of the Interstate Commerce Commission and of State com- 
missions, while almost all other public utiUty rates and prices 
are subject to the control of various public bodies. This 
method of control is more effective than the last ; the control 
is applied at the point at which the public is Ukely to suffer and 
the method is simple. Simplicity, however, has its dis- 
advantages. The fixing of prices is the most difficult part 
of business, even in railways, and the setting of maximum 
rates by a State authority is an illogical compromise between 
making the State responsible and making the company 
responsible for rates. If the maxima set by the State are 
high, they are no protection to the consumer, since the com- 
pany would, if left to itself, be deterred from raising rates to 
such a height by the fear of losing traffic ; if the maxima are 
low, then the company's freedom to fix its own rates within 
the limits of the maxima is illusory. Maxima tend to become 
minima ; if the companies are not to be allowed to raise a rate 
which proves unremunerative they will not experiment in 
lowering rates in the hope of attracting additional custom; 
which may be one reason why English railway rates, which 
fell quite steadily so long as the companies were free to raise 
them, have stopped falling since 1894, when the power to 
raise them freely was taken away. In the case of railways, at 
any rate, if the State is going to interfere with rates at all, 
it had better undertake the fixing of them altogether; and 



Monopoly and Combination 133 

if it undertakes the fixing of rates, which is the most diffi- 
cult part of railway administration, it will be forced in the 
long run to undertake the entire management of the rail- 
ways.^ 

Public Ownership and Private Operation. — Another com- 
promise between private enterprise and public control is the 
system under which the State constructs and owns the plant, 
but leases it to a company to operate ; French railways and 
English street-railways in most cases were originally under this 
system. The advantages claimed for the system are that it 
gives complete control without withdrawing the stimulus to 
enterprise and efficiency afforded by profit. The State can 
exact the full value of the monopoly as the price of the lease 
or in the form of rent ; it can insert among the conditions of 
the lease any limits on rates and charges which seem desirable ; 
it is relieved by the company of the task of dealing with large 
bodies of employees, a task from which it is contended that a 
representative authority, dependent on popular election, is 
unsuited, and the automatic check, which working for profit 
imposes on waste and inefficiency, is left unimpaired. Certain 
corresponding disadvantages are urged by those who advocate 
State operation as well as ownership of these services. The 
control is not complete and may be ineffective to protect the 
public ; if rates and charges are fixed, the company can vary 
the quality of the service ; the desire to make the most of the 
monopoly while the lease lasts is one incentive to extortion, 
the knowledge that the whole business must fall into the hands 
of the State on the termination of the lease is a check on enter- 
prise and the investment of new capital. The slow develop- 
ment of electric street railways in England, a generation 
behind the United States, is usually put down to the fact that 
the street railway companies were liable to be superseded by 
the municipalities. 

* Under the stress of war railways both in England and the United States 
have been taken over by the government. 



134 Economics for the General Reader 

Public Ownership and Operation. — Finally, the State can 
both own and operate these services, as it does in the case of 
posts and telegraphs, railways on the Continent, and an 
increasing number of gas, electricity, water and street 
railway services in both Europe and America. This tendency 
has been opposed on the grounds usually taken against 
anything socialistic. By removing profits it is alleged you 
remove the chief check on waste and the chief incentive 
to efficiency. The best economic and political areas do 
not necessarily coincide; a population of 100,000 may be 
quite large enough for a separate municipal government, but 
is much too small for a separate electricity supply. Public 
management of these services, it is alleged, will result either 
in a bureaucracy as unaccountable to public control as 
any private employer, or in management by politicians who 
will be guided in their decisions not by technical knowledge, 
but by the agitation of voters as ignorant of technical 
considerations as themselves. In reply to such objec- 
tions it is urged that it is only by supplying these services 
itself that the State can be sure of securing the profits of 
monopoly and protecting the public against extortion. The 
interest of the consumers, who can influence the management 
through their votes, is as powerful an incentive to efficiency 
as is the desire for profits under private enterprise. Each 
party to the controversy contends that in practice the method 
of management which it advocates shows the greatest effi- 
ciency and economy. 

Extension of Public Ownership. — While the controversy 
continues, the tendency is for these monopoUstic industries 
to be taken over more and more by the State. Moreover, 
the tendency is older than the controversy ; a large number of 
city waterworks in the United States and municipal gas 
undertakings in England, for example, had been municipalized 
before any of the existing sociahstic organizations had been 
founded. The tendency is the outcome of practical considera- 



Monopoly and Combination 135 

tions, influencing city councilors and administrators who 
were uninterested in theoretical discussions on the province of 
the State. The services are all essential services, so essential 
that public control is of greater public importance than low- 
ness of cost. The management of them is, compared with 
the management of any export industry, simple, since the 
market risks involved are so sh'ght ; foreign competition is 
impossible, the demand is steady and easily calculated, all the 
consumers are on the spot. Hence as the State extended its 
functions, these industries were naturally the first it would 
undertake. The industries are not only local in their services, 
but within their locality they serve a very large proportion of 
the population. Every one needs water, gas, or electricity, a 
postal service, street and steam railways ; hence public 
management of these services means management by the 
consumers through their representatives, and these State 
and Municipal industries are merely a special case of the 
cooperative movement which we examined in the last chapter. 
In the case of the railways of continental Europe another 
consideration enters in. The States have all long land 
frontiers ; the railways are therefore an integral part of the 
system of national defense. The governments wished the 
railway systems to conform to strategic as much as to economic 
requirements, and to secure this end they have undertaken a 
greater share in the construction and control of them than the 
governments of the United Kingdom and America had any 
need to do. 

Relative Nature of Problem. — The question as to efficiency 
of management cannot be decided in the abstract, and is a 
political rather than an economic question. It is a waste of 
time to discuss what the State can or should do in the economic 
field as if the State were always and everywhere the same 
thing. " The State " is one thing in Prussia where there is 
a long tradition of administrative efficiency, another in the 
United States where the " spoils system " has not on the whole 



136 Economics for the General Reader 

encouraged self-sacrifice and devotion in pubKc officials, 
and where the tradition of laissez-faire is much stronger. 
" Municipal enterprise " means one thing in Cleveland, Ohio, 
where as a result of a progressive electorate men rule the city 
who give to the public service practically the same care and 
ability that they give to their own businesses ; it means an- 
other in Philadelphia, where local government authorities 
are more under the influence of vested interests and pro- 
fessional politicians. Efficiency in these services depends 
more than on any other consideration on the appointment of 
the best men to the positions of direction and management; 
there is nothing in the nature of representative government 
itself to make one think that a municipal committee or State 
department will be more efl&cient or less efficient than the 
directorate of a corporation, that officials appointed by the 
one will be more efficient or less efficient than officials appointed 
by the other. In both cases jobbery and influence are possible ; 
and while corruption is a greater evil in the public service than 
in private trading, a comparison of governments in different 
countries, or in different areas of the same country, does not 
suggest that there is least corruption where the government 
restricts its activities most, but rather the reverse. The limits 
within which " the State " can undertake economic services 
are set not solely by economic considerations, but at least 
as much by the public spirit and social traditions of the citi- 
zens. 



CHAPTER VIII 
MONOPOLY AND COMBINATION {Continued) 

I 

The Tendency to Monopolistic Combination 

Private Business Monopolies. — The tendency to monopoly 
is not confined to industries in which technical economy 
requires monopoly ; it is found in many branches of industry 
where technical considerations do not necessitate it, and the 
motives which lead competitors to combine and eliminate 
competition are found in every field of economic activity. 
Competition among sellers tends to force prices down, the 
interest of sellers lies usually in keeping prices up ; this is 
usually the first motive inducing producers to combine. 
Competition, again, introduces new risks and accentuates the 
risks inherent in a system of production in anticipation of 
demand. In a competitive industry every producer has to 
estimate not only the total demand for his product, but also 
the amount that his competitors intend to produce and the 
proportion of that total demand which he will be able to 
supply ; a monopolist, controlhng and therefore knowing 
exactly the supply, would have to estimate only the demand, 
and would run little risk of " spoiling the market " by glutting 
it. Competition diminishes profits in another way. We 
speak of the market for any product, as if competition were 
always active throughout the area and between all the sellers 
of the product. In practice such a market is made up of a 

137 



138 Economics for the General Reader 

large number of smaller markets determined by locality, 
interest, custom ; every firm has its own "market," consisting 
of a number of customers who normally can be relied on to 
deal with that firm ; their custom constitutes the firm's " good- 
will." When trade is bad, however, the barriers between these 
subordinate markets are broken down, local markets are 
invaded by the products of firms at a distance, " goodwill " 
goes for nothing. The desire to prevent this invasion of their 
market, to secure their market and a steady trade by depriving 
their customers of any alternative source of supply, is a chief 
motive of combination, patents, brands, trade-marks and all 
other forms of monopoly. 

Corners. — Monopolistic combinations have been classified 
by Mr. Macrosty in accordance with their relative perma- 
nence. The lowest form of combination is the temporary 
combination of dealers to get control of the supply of a product 
for a limited period and force prices up. Such operations on 
produce exchanges are called " corners," and are tempting 
to speculators on those markets in spite of the risk of failure, 
first, because they can get control of the produce coming 
into the market by paying " differences " only, not the entire 
price of the produce, and, secondly, because the other dealers 
on the market, having sold for future delivery without fore- 
seeing the " corner," will be forced to buy at the monopolist's 
price, or fail to meet their obligations ; they cannot wait for 
prices to come down. 

Price Agreements. — Next in order come informal agree- 
ments among dealers to observe a price list. Such agree- 
ments, constantly broken and constantly renewed, until they 
acquire a sort of sanction in the " custom of the trade," have 
always existed, especially among retailers, and, in the opinion 
of Mr. J. A. Hobson in 1906,^ extracted more from the con- 
sumer in the way of excessive prices than all the trusts and 
industrial combinations put together. Such agreements have 
1 Evolution of Modern Capitalism, p. 191. 



Monopoly and Combination 139 

given way in many cases to formal associations, with con- 
stitutions and officials to fix prices and regulate terms of 
sale. The weakness of these associations is that by raising 
prices they encourage their members to increase their output. 
The market will not take the increased output at the old 
price, and the temptation to secure the large profits, which 
must accompany the increased sales of the first firm to break 
the agreement and cut prices, is usually too strong to resist. 
Hence price agreements often develop into agreements to con- 
trol output as well as to maintain prices ; and these in turn, 
since the temptation to secure additional trade by cutting 
prices below the agreed Hst is still in some cases too strong, 
give way to arrangements by which the entire trade is pooled 
and the receipts shared in certain fixed proportions. In 
England and the United States agreements of this nature, 
however comprehensive, are always insecure, because they 
cannot be enforced at law. The Common Law regards 
agreements in restraint of trade as contrary to public pohcy ; 
consequently, if one of the parties to an agreement of this 
nature breaks it, the other parties cannot sue him for breach 
of contract or force him to pay any penalty which the rules 
of the association may impose. The Sherman Anti-Trust 
Law and the various state laws of Hke import forbid and 
directly penalize such agreements. 

Trusts. — Hence the price agreement or " pool " does not 
constitute a complete fusion of interests ; there is always a 
strain on the loyalty of some, especially the stronger, of the 
parties to it. When trade is good, all can do without the 
association ; when trade is bad, it may always pay the stronger 
members to break away, and, by cutting prices, capture their 
competitors' market. Profits depend on output or turnover 
quite as much as, if not more than, they do on prices. Hence 
the leaders of industries, who desired to effect a complete 
fusion of interests, have been forced in the United States to 
amalgamate the competing firms into one, and form what is 



I40 Economics for the General Reader 

usually called a " trust." The term " trust " was originally 
applied to a device for fusing interests without complete 
amalgamation; a corporation was formed which acquired, 
usually in exchange for its own stock, a bare majority of 
the shares of each of the competing firms in the industry ; 
a bare majority of shares in a corporation gives com- 
plete control of the company; hence the central company, 
the " trust " proper, could control all the firms in the trade. 
But this device was declared illegal as being in restraint of 
trade, and the complete amalgamation took its place. Amal- 
gamation may be effected by an exchange of shares between 
the combining companies ; but usually a new company is 
floated and buys the separate firms. 

The " Kartel." — In Germany the Common Law rule is 
different, and agreements to regulate prices can be enforced 
in the courts. This difference has made possible federations 
as permanent and secure as the complete amalgamations of 
the United Kingdom and America. In the kartel, the typical 
German combination, the competing firms combine to estab- 
lish a single selling agency. They agree with one another by a 
legal contract to sell to this central selling agency alone, and 
the agency undertakes to take their whole output; in the 
same contract the proportion of the entire output which each 
firm may produce is settled. By this arrangement the single 
agency acquires control of the product of the whole industry, 
and can vary prices — and, with the consent of the members, 
output — to secure the greatest possible net profit. At the 
same time the firms retain their independence for purposes 
of internal management. Thus the kartel retains separate 
management of production while securing unified manage- 
ment of selling. 

Difficulties of Combination. — After allowing for all the 
difficulties of successfully working a monopoly, it is surprising 
that there are not more industrial monopolies ; but combina- 
tions, though attractive, are not easy to form. The first 



Monopoly and Combination 141 

obstacle to their formation is the difficulty of bringing together 
to a common agreement a number of firms that have known 
one another previously only as competitors ; the feeling of 
hostility and emulation persists even when the loss and 
worry involved in fighting have been recognized. This feeling 
is reenforced in the case of many private firms by a pride in, 
and attachment to, their independence, which they are un- 
willing to sacrifice even on advantageous economic terms. 
The inequality in competing strength of the separate firms in 
most industries is another obstacle ; the strong firms can get 
along very well without the aid of a combination, while a 
combination that did not include them would be unable to 
control the market. A period of bad trade, following on and 
contrasting with a period of good trade, is usually needed to 
produce the state of mind in which projects of combination 
are generally welcomed ; when trade is good, every efficient 
firm can get its prices without the aid of combination, the 
scramble for orders on a declining market is needed to remind 
producers of the folly (from their point of view) of competition. 
The mere task of negotiating a combination — inducing 
competitors to meet, adjusting confficting interests, allowing 
" goodwill," and settling the terms generally on which the 
separate businesses are to be taken over — is formidable, 
and calls for a high degree of diplomatic skill and business 
statesmanship. 

Extent of Combination. — For these among other reasons 
few industrial combinations that have been formed have been 
inclusive of the whole trade. Some firms in the market have 
stood out, or, if the combination was originally inclusive, new 
firms have come into the market. If only a small proportion 
of the trade, however, is outside the combination, its influence 
over prices will not be seriously impaired ; a combination with 
70 per cent of the trade in a market is in practically as strong 
a position as one with 100 per cent ; the latter's control of 
prices is usually as strictly limited by potential competition. 



142 Economics for the General Reader 

A more serious outcome of the difficulties attending the forma- 
tion of combinations is that they are nearly always over- 
capitalized, and this in two ways : the actual capital engaged 
in the industry may be greater than is needed to satisfy the 
normal demand of the market at a remunerative price ; and 
the nominal capital on which dividends are paid, if any 
profits are earned, may be so much greater that dividends 
become the exception rather than the rule. A trust is formed 
at the end of a boom; during the boom old firms have ex- 
panded and new firms have been established, with the result 
that when trade becomes normal, the product which the in- 
dustry can put on the market is far greater than the market 
will take at a price high enough to repay the cost of production ; 
yet the whole of this producing capacity has to be brought 
into the combination, or the object of the combination, 
monopoly, will not be achieved. When the United States 
Steel Corporation was formed it had a producing capacity 
more than half as great again as the normal output of the 
United States heavy steel industry, yet it did not include the 
whole trade. The organizers of a trust, to secure a monopoly, 
have to induce all or most of the firms in the industry to come 
into the combination; this is known, and the knowledge 
induces firms to stand out for a higher and a higher price as the 
number of outstanding firms decreases ; it is said that the 
largest of the firms which were combined in the United 
States Steel Corporation was able to insist on a price 50 per 
cent higher on the same valuation as the other firms, and 
to secure payment exclusively in bonds. Hence the public, in 
being asked to take up the shares of the new trust, are being 
asked to pay a price for the industry as a going concern often 
far higher than is justified by the earnings of the industry 
even in a trade boom. In addition, the profits which are 
expected from monopoly are often capitalized and added to the 
price at which the investing public is asked to purchase the 
industry, while no allowance is made for the reduction in out- 



Monopoly and Combination 143 

put which will be necessary to keep prices up and for the 
disuse of plants which have only been bought up to extinguish 
competition. Indeed a principal motive of the promoters of 
trusts is the profits which they can make at the expense of 
the investing public; the motives of the investors in sub- 
mitting to be fleeced are more difficult to understand. In the 
case of kartels, where the only new company formed is the 
selling agency, which has usually a nominal capital held 
exclusively by the constituent firms, the corresponding 
difficulty lies in determining the total output and the partici- 
pation in it to be allotted to the different firms. To allow 
every firm to produce to its utmost capacity would flood the 
market and make it impossible to keep prices up ; yet the 
stronger firms will not join the kartel if they are to be prevented 
from taking advantage of their strength. Hence the kartel 
is often committed at the outset to an amount of production 
so great that it has to offer bounties on export to its constituent 
firms, to induce them to send some of their output into foreign 
markets ; just as the American trust practices " dumping " 
abroad in order to keep up prices in the protected home market. 



II 

Conditions Favorable to Monopolistic Combination 

Narrow Localization. — The formation of a combination is 
facilitated if the industry is locaUzed. If the firms to be 
combined are situated close together, their heads will fre- 
quently meet, will know one another and one another's 
circumstances, and be predisposed to combine. Probably 
joint action to restrict the severity of competition will have 
taken place before the proposal to eliminate competition by 
combination is mooted. Bonds between the separate firms 
will already exist in the local trade associations for marketing, 
securing technical efl&ciency, and dealing with labor. The 



144 Economics for the General Reader 

importance of this influence is illustrated by the difficulty 
of forming, and still more of maintaining, international 
combinations and agreements; they may be expected to 
come, but at present their stability is as inferior to that of 
national and local combinations as are international alliances 
and international law to national associations and national 
laws. 

Restriction of Competitors. — While the influence of 
locality is important, however, the condition that most 
favors monopolistic combination is some natural or social 
limitation on the number of firms engaged in an industry. 
When an industry can be carried on only on a large scale and 
with large capital, it is difficult for new firms to enter it, and 
the way is made open for combination among the firms in it. 
For this reason the heavy steel industry has proved a favorable 
field for combination, and the companies carrying on liner 
traffic, few of which in England have a capital of less than 
half a million pounds, are all in rings or conferences. Any 
kind of natural scarcity in an industrial material favors com- 
bination ; the anthracite coal industry is controlled by close 
combinations both in England and America, and the petroleum 
industry has the most famous of trusts. Climate may have 
this effect; one of the most successful English trusts is the 
Fine Cotton Spinners' and Doublers' Association, which 
carries on a trade restricted by climate and skill to a small 
area in Lancashire. Soft water for bleaching and dyeing, 
and a prescriptive right to turn an objectionable effluent into 
streams, have been of influence in the formation of combina- 
tions. Even more favorable to concentration is some pre- 
viously existing element of monopoly, such as that afforded 
by the possession of patent processes, distinctive brands, and 
trade-marks ; the chemical and aniline dye industries are 
concentrated on the basis of patents, the tobacco and snuff 
industries on their brands, the American chewing-gum industry 
and English cocoa industry on their flavors. The State may 



Monopoly and Combination 145 

limit entry into a trade ; when it does so, it encourages com- 
bination ; saloons and railways are examples. The control 
of one monopolistic industry naturally limited may be used 
as a means of securing monopoly in another; railway dis- 
crimination was one of the means by which the Standard 
Oil Trust was formed, and was also largely the basis of the 
Chicago Beef Trust. 

The Tariff. — One influence favoring trusts requires special 
treatment, since it is often put forward as the only cause of 
combinations, namely, the influence of a protective tariff. 
That it is not the only influence is shown by the fact that 
monopolistic combinations exist and are growing in the 
United Kingdom under Free Trade ; that it is a condition 
favorable to combination is suggested by the greater develop- 
ment of the combination movement in the United States and 
Germany. A protective tariff seems to encourage and to 
facilitate combination. The way in which it encourages com- 
bination is illustrated by the history of the Sugar and Whisky 
Trusts in the United States. The high protection afforded 
to these industries encouraged such a rush of capital into them 
that competition within the protected market became much 
keener than competition outside ; excessive competition led to 
price-cutting and loss all round, and encouraged the com- 
peting firms to combine as the only means of avoiding bank- 
ruptcy. How excessive was the overproduction produced 
by the bait of a protected market is indicated by almost the 
first action of the two trusts formed ; the Whisky Trust closed 
down sixty-eight of the eighty distilleries it took over, the 
Sugar Trust seventeen of its twenty-three refineries. A 
protective tariff facilitates combination, since it offers com- 
peting firms freedom from foreign competition, and therefore 
a monopoly of the home market, if only they can agree to 
extinguish competition among themselves. The control of a 
national market is much more of a " business proposition " 
than the control of a world market. Certainly the first thing 



146 Economics for the General Reader 

a protectionist government will do, if it is seriously opposed 
to the trust movement, will be to lower or abolish its tariff. 
Trusts not only owe much to tariffs, but react on them by 
enormously strengthening the interests opposed to the re- 
duction or repeal of protective duties. 

Ill 

Difficulties of Monopolistic Combinations 

Difficulties in Internal Organization. — The troubles of the 
would-be monopolist are not ended when his combination is 
formed. If the monopoly is an amalgamation and over- 
capitalized, ordinary good management is not sufficient to 
produce dividends ; if it is a pool or kartel, there will be con- 
stant quarrels over the proportions in which the trade is dis- 
tributed among the constituent firms, and big firms will upset 
the equilibrium of the organization by buying up smaller 
firms and absorbing their rights in the trade. No monopoly 
again, however complete, is unaffected by the general fluc- 
tuations of trade. In times of declining trade the German 
kartels have been forced to adopt the expensive device of 
paying bonuses on export in order to keep up prices in the 
home market, the only market where their monopoly is 
effective ; the American trust meets the same difficulty by 
the practice of " dumping " a portion of its output abroad at 
any price. When we were studying the relative advantages 
of large- and small-scale enterprise, we found that one of the 
difficulties of the large concern was that the difficulty of 
management was out of all proportion greater in the case of 
the large concern. Similarly the concentration of the manage- 
ment of a whole industry into a few hands is economical, as 
will be seen in a moment, provided that the few hands are 
equal to the task ; at the same time there is a risk involved, the 
risk of putting all the eggs into one basket, and several in- 



Monopoly and Combination 147 

cidents in the history of the trust movement emphasize this 
risk. The great Steel Trust was formed, it has been said, to 
remove Mr. Carnegie from the industry before he had absorbed 
the whole of it; having achieved their object and removed 
Mr. Carnegie, the promoters were unable to find any one who 
could do the work which Mr. Carnegie had been doing ; men 
who can organize from one center the whole of a great industry 
are difficult to find. The mammoth business in competitive 
industry is usually based on exceptional abiUty, and industrial 
combination is no adequate substitute for such ability. 
Henry Ford standing alone has been the envy of every trust 
promoter. 

Substitution and Potential Competition. — The power of 
the trust over prices is limited not only by the general move- 
ments of trade, but by two less obvious but even more im- 
portant influences, the competition of substitutes, and poten- 
tial competition. Just as a railway plying between two ports 
has to hmit its rates to the figure at which goods can be sent 
by water, plus an allowance for the greater convenience and 
speed of railway transport, so an oil trust must not raise its 
prices to the point at which it pays consumers to install gas 
or electricity, or to revert to candles. The United Alkali 
Company was formed to include all the firms using the Le 
Blanc process of making alkali and bleaching powder ; the 
effect was to stimulate invention, until the electrolytic method 
of making bleaching powder, already known in the laboratory, 
was made commercially profitable. The French Copper 
Syndicate of 1888 foundered on the same rock, the competition 
of substitutes. The other influence, the danger of stimulating 
competition where it does not already exist, is naturally more 
difficult to illustrate ; just as the possibility which exists under 
the English constitution of creating new peers converted the 
House of Lords' Veto from an absolute to a suspensory veto, 
although the power has not actually been exercised for two 
hundred years, so the possibihty of attracting competition 



148 Economics for the General Reader 

converts a monopolist's control over prices from an absolute 
control to fix them where he will to the more limited power of 
delaying a fall and speeding up a rise; the example of the 
Steel Trust, however, is sufficient to indicate what is possible. 
The trust began its career with 80 per cent of the heavy steel 
trade of the United States ; its capacity was great enough to pro- 
duce nearly 60 per cent more than the greatest actual aimual out- 
put hitherto reached in the United States ; at the end of eight 
years, though its productive capacity had increased, its share 
of the trade had sunk to 50 per cent. The case is the more 
significant, since it occurred in an industry in which a large 
capital is needed to estabhsh a new firm and the trade risks 
are great. A monopolist, by raising prices or doing anything 
else to suggest that he is earning exceptional profits, tempts 
other capitalists to enter the industry ; and it should be noted 
that they are tempted not only by the prospect of sharing the 
profits if the prices remain high, but also by the alternative 
hope that the monopolist will be induced to buy them out on 
their own terms, if the competition forces prices down. 



IV 

Advantages of Monopolistic Combination 

Productive Advantages. — It has been necessary to give 
some space to explaining the obstacles in the way of establish- 
ing monopoly in competitive industry, because it is at first 
sight surprising that the trust movement has not developed 
further than it has, and that its history is strewn with so many 
failures. In spite of failures, however, the development of 
the movement proceeds; apparently we may expect the 
" combine " of firms to become as normal in the twentieth 
century as the large firm has become in the nineteenth ; for, 
while the chief motive of combination is the desire for monop- 
oly, and complete monopoly is rarely achieved, the result of 



Monopoly and Combination 149 

combination is a possibility of economies so great that com- 
plete monopoly becomes unnecessary for high profits. That 
it is by economies rather than monopoly that great profits are 
made is suggested by the success of those " trusts," like Messrs. 
J. & P. Coats, the thread manufacturers in England, and the 
General Electric Co. in the United States, which were formed 
by the amalgamation of a small number of strong firms without 
any attempt to comprehend the whole trade, and of those 
great firms, such as the Carnegie Steel Works and the Ford 
Motor Company, which have grown from small beginnings 
without any attempt to secure monopoly, and have come 
nearer to monopoly than most combinations which set out 
with monopoly as their object. 

Eliminating Competitive Wastes. — What then are the 
special economies within the reach of these trusts ? They are 
simply an extension of the economies of large-scale production, 
and very similar to the economies of localized industry. Just 
as the large firm can specialize departments, the trust can 
speciaHze finns. If it is a combination in a localized industry, 
some such specialization will have arisen already, and the 
trust will merely arrange that the firm with a specialty shall 
devote its whole resources to that specialty. The trust is 
able to carry the specialization of labor further and to retain 
more highly specialized skill ; its abiHty to retain the best 
legal skill has been frequently illustrated. With its central 
control of the industry it can develop resources, such as the 
pipe-lines of the Standard Oil Trust, which no smaller cor- 
poration could finance. Many trusts have taken steps to 
secure the sources of their raw material. Along with the 
economies of greater specialization goes a saving in general 
expenses. To sell its goods, a firm in a competitive market 
has to maintain a system of travelers, agents, advertise- 
ments, which is constantly growing in expense. One firm, 
to give it a competitive advantage over the other firms, 
adopts some new advertising device ; all the other firms are 



150 Economics for the General Reader 

forced in self-defense to follow suit ; the result is that none 
gains any advantage over the rest ; they are as they were, but 
the expense of the advertising device has been added to the nor- 
mal costs of the trade. A trust can reduce this kind of expen- 
diture, or at least stop its growth. One set of travelers can 
now take out the samples of as many firms as there are in the 
combination; the trust, if it advertises (as it usually must), 
can regulate its expenditure on advertising itself, instead of 
having expenditure constantly forced upon it by competitors. 
The centralization of purchases and sales may allow of saving, 
certainly the centralization of finance and insurance should be 
an economy. Above all, it is a great economy to know, 
instead of having to guess, how much of their product is going 
to be put on the market ; nothing is so conducive to cheap 
production as a steady output, no obstacle to a steady output 
is so great as the action of a large number of producers acting 
independently, each endeavoring to steal the other's trade 
and uncertain what proportion of the aggregate demand of 
the market he can safely offer to supply. A minor economy 
arising from central control is the saving of transport charges 
in the form of cross freights, by supplying customers from 
the nearest plant. 

Competitive Advantages. — All these are social as well as 
private economies, since they mean an equal output for a less 
expenditure. The combination, however, has certain advan- 
tages over the independent firm in securing trade and con- 
trolling prices, certain competitive advantages as distinct from 
the productive advantages we have considered so far. The first 
of these is the boycott. If a trust has control of a large 
proportion of the supply of any commodity, the larger users 
of the commodity will probably be unable to meet their 
requirements without buying from the trust at times. The 
trust can then refuse to supply them unless they undertake to 
buy exclusively from the trust; by boycotting its com- 
petitors' customers it can force them to boycott its com- 



Monopoly and Combination 151 

petitors. A slightly different method of securing the same 
end, a monopoly of custom, is the method of the shipping 
conferences : a rebate, usually of 10 per cent, is allowed on 
all freights to shippers who confine their freights to the 
lines in the conference. The second weapon of the trust is 
price differentiation. Where the trust has a monopoly it 
can keep prices up ; with the revenue derived from these high 
prices at its disposal, it can afford to cut prices to bare prime 
cost of production in markets where it has not a monopoly, 
and so drive out its competitors. Under competitive condi- 
tions coal is cheapest at the pit-head and increases in cost as 
the distance from the pit increases, owing to transport ex- 
penses; the Westphalian Coal kartel charges its highest 
prices in the coalfield itself, and reduces them in successive 
zones to meet the competition of coal from other coalfields. 
Differentiation is possible not only between districts but be- 
tween individuals ; under competitive conditions a buyer who 
found that the firm he was buying from was supplying some 
one else at a lower price would take his custom elsewhere ; 
under monopoly he has no alternative. Trusts cut prices 
on a bigger scale, naturally, than independent firms when 
they do engage in price- wars ; with their enormous capital 
and predominant control of supply they can hold out for 
a rise longer, and resist a fall in price longer, than a single 
firm with competition to think of. Their chief competitive 
advantage, however, is perhaps their knowledge of the supply ; 
in bargaining with customers, the trust knows, the customer 
does not know, what the available supply is ; hence the trust 
dare, and the customer dare not, stand out for its price. 



152 Economics for the General Reader 

V 

Vertical Combination 

We have been concerned in this chapter with the attempt 
to secure a monopoly of an industry or of one stage in an 
industry by the combination of all or most of the firms 
engaged. It should be noticed that there is another form of 
combination, which has different objects, although it may 
tend ultimately to the establishment of monopoly. This is 
the combination of firms at different stages in the same 
industry, " vertical " combination as it has been called in 
contradistinction to the " horizontal " combination, which we 
have been considering. It is due to the same pressure of 
competition on profits as leads to horizontal combination; 
it seeks to escape from the pressure, however, not by combining 
competitors at the same stage, but by combining a firm with 
firms that supply it with its raw material or take from it its 
product. Such combination can be most easily effected by 
the purchase by one company of shares in the companies from 
which it usually buys its materials and to which it sells its 
product. This kind of combination is often a step towards 
the other kind of combination, because competitors will often 
associate to acquire control of one of the sources of their raw 
material or for one of the outlets for their product, and, having 
once associated for that purpose, end by associating for all 
other purposes as well. 



CHAPTER IX 
/ MONEY 

I 

Money and Coinage 

Barter and Exchange. — The modern producer is always 
a specialist ; every one in modern society derives his income 
from specialized labor or specialized property. This special- 
ization is, we have seen, possible only because the specialists 
cooperate : each by himself is incapable of satisfying his 
simplest material wants, together they can produce all that 
all need. The speciaUsts, therefore, must exchange their 
specialties. Exchange may take place in two ways, directly 
and indirectly. The direct exchange of goods we call barter, 
the indirect exchange, through some medium, we call buying 
and selling. Barter is impracticable as a rule in a modern 
society, since it involves what has been called a " double 
coincidence of wants " ; under a system of barter, the barber 
who wants bread has to find not merely a baker but a 
baker who wants his hair cut, the baker who wants his hair cut 
must find not merely a barber but a barber who wants bread. 
Even when two people who want each other's services have 
come together, they may be unable to agree as to terms ; the 
baker may consider two loaves a fair equivalent to three 
hair-cuts, while the barber demands a loaf each time he cuts 
the baker's hair. The degree of specialization which char- 
acterizes modern industry could never have been reached 



154 Economics for the General Reader 

under a system of barter ; It is too minute, too complicated, 
too extensive both in space and time ; the increasing use 
of money was both sign and cause of the transition from 
the primitive to the modern economy. 

Variety of Exchange Media. — The medium of exchange 
may be almost anything, provided that it is generally ac- 
ceptable. The sole object of having a single medium of ex- 
change is to obviate the inconvenience of barter, and the 
inconvenience remains if some sellers refuse payment in the 
medium. The reason why a man with anything to sell 
will always accept payment in money is that he knows that 
every one from whom he may wish to buy will accept money 
in payment; if any number of people refuse to accept the 
medium in exchange for their goods, then its usefulness dis- 
appears. Cattle, slaves, tobacco, salt, leather, beads, silver, 
gold, paper, and several other things have in different coun- 
tries and at different times been used as the medium of ex- 
change, and, consequently, as the standard of value. They 
served just so long as they were generally acceptable ; they 
gave way to something else, or to barter, when for any reason 
many people hesitated to accept them in payment for goods. 

Importance of " Intrinsic " Value. — Though paper money 
can circulate (under conditions explained later), it has been 
found in practice that the only way to secure in your medium 
of exchange this fundamental quality of general accepta- 
bility is to choose as your medium some commodity which 
has a utility for other purposes than facilitating exchange. 
Tin counters would pass from hand to hand as easily as 
golden sovereigns, and would make as good a medium of 
exchange, if people would accept them ; but in practice it 
has been proved over and over again that people wiU not 
part with their goods in exchange for counters with no in- 
herent utility ; in the long run they have confidence only in 
money which derives its value not from the fiat of govern- 
ments but from its intrinsic physical properties. The use 



Money 155 

of bank-notes, checks, and bills of exchange may seem to 
contradict this principle, since the paper of which they are 
composed has no relation to their value. The contradic- 
tion is only superficial ; bank-notes and other credit in- 
struments are legal documents giving the owner a legal claim 
to so much gold, and it is only because they represent this 
claim that they are acceptable ; if anything happens to 
create doubts that the claim will be met, they lose their ac- 
ceptability immediately. So far from being valueless, be- 
cause the paper on which they are written is valueless, they 
are forms of property in just the same sense as bearer Stock 
Exchange securities or the copyrighted manuscript of a 
book ; they are the title-deeds of property in bullion. 

Standard of Value. — Money is not only the medium of 
exchange ; it is also the standard of value. Since most ex- 
changes take place through the medium of money, most 
goods and services come, at some time or other, to be com- 
pared with money. There is nothing else with which they 
are so regularly compared. Hence the medium of exchange 
becomes a common denominator of the relative values of 
different goods and services, and their values are usually 
stated in terms of money, i.e. as prices. 

Precious Metals as Money. — The reason why the pre- 
cious metals have superseded other conmiodities as money 
will now be evident. They have to a greater degree than any 
other commodity the qualities required in a medium of ex- 
change and standard of value. They are compact ; silver 
displaced copper, and gold silver, as standard money, be- 
cause large payments in copper or silver were so cumber- 
some. They are durable; it has been estimated that it 
would take eight thousand years for a five-dollar gold piece 
to wear out completely — cattle are conspicuously lacking 
in this quality. They are divisible without loss of value; 
in this quality cattle and most early forms of money are 
again conspicuously lacking, and precious stones, which 



156 Economics for the General Reader 

have most of the other qualities required in money, fail in 
this respect. 

Characteristics of Precious Metals. — Gold and silver are 
easily recognizable, a quality necessary to check counter- 
feiting. Finally they are not subject to great changes in 
quantity. This last quaHty is most important in a standard 
of value ; one does not want one's standard of other things 
to be constantly changing itself. Corn, for example, would 
make a bad standard of value, because its quantity changes 
with every change in the weather and other conditions that 
affect the harvest; a suit might exchange for a quarter of 
corn one year, and the next year, although the demand for 
suits and the conditions governing the supply of them re- 
mained unchanged, might exchange for a quarter and a half 
of corn, a record harvest having occurred in the interval. 
Gold and silver, on account of their great durability, are less 
subject to such changes than any other commodities ; each 
year's product is merely a small addition to an enormous 
stock already existing. Paper documents are even more 
compact, divisible, and recognizable than the precious metals, 
and will therefQre make a more convenient currency, provided 
that they can be given that quality of general acceptability 
which the precious metals possess by virtue of their rarity 
and intrinsic beauty. 

Coinage. — For convenience of handling and exchange 
gold and silver are usually coined. At first they were measured 
by weight ; a " pound " was a pound weight of silver. The 
process of coining was merely the authoritative stating and 
guaranteeing of weight and quality, to save the trouble of 
weighing and testing the metals each time a purchase was 
made. Metal stamped by authority in this way circulated 
more freely, because it was more convenient, than unstamped 
bullion. Governments made it the legal medium of exchange, 
and assumed the monopoly of the coining process. Usually 
the Government, in return for the convenience of coined 



Money 157 

money, would make a charge, putting less than a pound's 
weight of silver into a pound of money ; this profit or charge 
for coining is called seigniorage. To-day most goverrmients 
take no seigniorage, i.e. make no profit on the coining of 
bullion. In some cases they take what is called brassage, 
i.e. they keep back out of the metal coined a quantity just 
sufficient to cover the cost of the coining process. In the 
United Kingdom even this charge is not made ; gold is taken 
at the Mint and coined into sovereigns without charge, one 
ounce of gold (eleven-twelfths fine) into ^{^^ sovereigns. 
In practice, however, the holders of bullion take it not to the 
Mint but to the Bank of England, where they are credited 
with £3 : 17 : 9 for every ounce of gold (eleven- twelfths fine), 
instead of £3:17:10^, the exact equivalent; the sacrifice 
of i^d. on the ounce of gold is made up for by the saving 
of the time taken by the process of coining. In the United 
States a brassage charge is made to cover the cost of preparing 
the bullion for coinage. No charge is made for coinage itself. 
An ounce of gold at the United States mints is worth 20.67. 
Practically all the gold mined in the United States goes in 
first instance to the government. 

Legal Tender. — Any commodity will serve as the medium 
of exchange, provided that it is generally acceptable ; general 
acceptability, however, as a rule is enjoyed only by a com- 
modity selected by Government as medium of exchange and 
" coined," or otherwise given the stamp of authority. The 
regulation of contracts is one of the most elementary func- 
tions of the State, and the contract of exchange, or sale and 
purchase, is one of the commonest and most important of 
contracts. To facilitate exchange the State selects one or 
more commodities as its standard money ; it makes it standard 
by giving it full legal tender. In the United States gold coin is 
full legal tender, i.e. the offer of it must be accepted in settle- 
ment of any debt. In addition, some subsidiary coins are 
usually issued as small change, which are legal tender to only 



158 Economics for the General Reader 

limited amounts, being considered merely token coinage, i.e. 
representative of the standard money, although in the United 
States the silver dollar enjoys full legal tender power. On 
the subsidiary or token coinage the mint makes a large 
profit, since the face-value is always greater than the bul- 
lion-value. It follows that metals used for token coinage are 
not given the right of free coinage ; to grant free coinage 
would be to make the owner of the metal a present of the 
difference between the bullion-value and the face-value of 
the coin. It follows also, for reasons that will be apparent 
when we have studied Gresham's Law, that the Government 
can issue only a limited quantity of token coinage, and must 
limit the amount to which it must be accepted as legal 
tender. In the United States fractional silver and copper 
coins are token coinage ; fractional silver is legal tender 
only to the amount of five dollars, the five-cent piece and 
the bronze cent only to twenty-five cents. 

II 

The Single Standard 

Freedom of Coinage. — When we say that the medium of 
exchange is selected by the State, it must not be thought 
that the State can select anything, and, by selecting it, 
force people to accept it. If for any reason the currency 
issued by the State and given the quality of full legal tender 
is not liked, it ceases to facilitate exchange, and becomes 
one of the greatest obstacles known to exchange. General 
acceptability, though increased by the State's action, is given 
to a commodity only by intrinsic utility; and money to do 
its work must therefore possess intrinsic utility or give a 
claim to something with intrinsic utility, in addition to re- 
ceiving the stamp of the Mint. To insure this association 
of intrinsic utility with standard money, the metal selected 



Money 159 

as standard money is usually given the right of Free Coinage; 
this means that the Government will accept for coinage any 
amount of the metal. In the United States this right is 
possessed only by gold ; the Mint will always accept gold 
and turn it into coin, while silver, nickel, and copper are 
coined only on Government account. If a Government 
charges brassage or seigniorage on its coinage, this is no 
limitation of the right of free coinage. The object of giving 
the right of free coinage to a metal is to insure that its value 
as bullion and its value as coin will always bear the same 
relation ; in the United States $20.67 ^.nd an ounce of gold 
are always of equal value, since the ounce of gold can at any 
time be turned into the $20.67. The reason for this pro- 
vision will be clear when we have considered Gresham's 
Law. 

Bimetallism. — Must there be only one standard of value, 
or may there be more than one? Until the nineteenth cen- 
tury governments saw no objection to maintaining two 
standards of value in circulation at the same time, namely, 
gold and silver. In 181 6, however, the United Kingdom 
demonetized silver, i.e. deprived silver of the legal attributes 
of full legal tender and free coinage, and all the other chief 
commercial countries have followed suit. Governments were 
forced to this action by the logic of facts ; the double standard 
was an illusion, in reality either gold or silver, not both, was 
the standard of value even when both enjoyed the privileges 
of standard money. Why this was so will be clear from an 
example. 

The coinage system of the United States was established 
by an act passed in 1792 and was based on Alexander Ham- 
ilton's famous Mint Report. A bimetallic system was pro- 
vided, namely with both gold and silver standard money at 
a ratio of i to 15. One ounce of gold, in other words, was 
equal for coinage purposes to 15 ounces of silver. In the 
market, however, the ratio was 1:15^. The result was an 



i6o Economics for the General Reader 

undervaluation of gold in terms of silver for monetary pur- 
poses. Under the circumstances practically no gold was 
brought to the mints for coinage purposes, and the real 
standard was for the time being simply silver. During the 
period 1834-183 7 several changes were made in the coinage 
laws the net result of which was a readjustment of the legal 
ratio from ai:i5toai:i6 (15.988) basis. But the market 
ratio remained at the 1:15^ level. Silver was thereafter 
the " dearer " metal for coinage purposes and began to dis- 
appear from circulation. After the gold discoveries in Cali- 
fornia in 1849 the market ratio declined to a level even below 
1 : 15-I, thus broadening the discrepancy between the market 
ratio and the legal ratio and hastening the withdrawal 
of silver from the monetary circulation. By 1853 the situa- 
tion had become so serious that a Subsidiary Coinage Act 
was passed reducing the bullion contents of the silver frac- 
tional money and thus giving it a coin value greater than its 
bullion value and discouraging its further melting or exporta- 
tion as bullion. In other words, in this period the standard 
became gold, and silver was supplanted. Silver was practi- 
cally demonetized by the act of 1873 but it was not until 
1900 that the government of the United States went defi- 
nitely and unequivocally on a gold basis. 

Thus, even when a Government tries to maintain the 
two metals in circulation together as standard money, it 
fails, because the relative value of the two metals is con- 
stantly fluctuating with the varying rates of their produc- 
tion ; the metal undervalued by the mint tends to disappear 
from circulation, so that the country is really on a mono- 
metallic basis, the metal overvalued by the mint being the 
actual standard of value. Only if the chief commercial 
countries of the world combined to maintain both metals 
in circulation could this result be prevented. The use of 
them as coin is much the most important use of the precious 
metals ; a " combine " of mints therefore could control the 



Money i6i 

bullion market and fix the values of bullion, just as any 
strong combine can to some extent control values. Then 
a fixed ratio between the two metals could be maintained in 
the bullion market, and no divergence between the Bullion 
Ratio and the universal Mint Ratio need occur. Such a 
treatment of the precious metals would constitute not a 
double standard but a joint standard; its advantage over 
existing monometallic monetary systems would lie in the 
fact that the value of gold and silver together would probably 
fluctuate less than the value of either gold or silver separately. 
It would also get rid of the difficulty caused by the absence 
of a par of exchange between gold-using and silver-using 
countries. 

Ill 

Gresham's Law 

Explanation. — The disappearance of the undervalued metal 
when two metals are minted as standard money is only one 
illustration of a general tendency, that has been called " Gresh- 
am's Law," after an Elizabethan finance minister who was 
supposed (incorrectly) to have discovered it. The tend- 
ency is for " bad " money to drive out of circulation " good " 
money. " Bad " money may be either coin, the value of 
which as metal is very much less than its face-value, or 
paper, which cannot be exchanged for good coin. Coin 
may become bad money by being clipped or sweated ; or 
the Goverimient may have debased it by increasing the 
proportion of alloy or reducing the weight without changing 
the denomination. The English pound declined from 4995 
grains of silver in the eleventh century to 288 grains in the 
reign of Edward VI. Or a change in the ratio of gold to 
silver in the bullion market may, as in the case of the English 
guinea, destroy the identity between the face-value and the 
bullion- value of one of the two metals. Paper money be- 



1 62 Economics for the General Reader 

comes bad money whenever it is issued in excess of the re- 
quirements of the community for a medium of exchange ; 
it usually is issued in such excess when it is the only form of 
currency. Gresham's Law may operate in more than one 
way. The bad money will be used to pay debts, while the 
good money is hoarded ; every one tries to get rid of a bad 
shilling, so that bad shillings circulate. The good money 
disappears chiefly, however, by being exported ; the Govern- 
ment cannot compel foreign merchants to accept its bad 
money in payment of their debts, they will usually accept 
only money which is worth no less as bullion than as coin; 
hence the good money is constantly being saved up to pay 
foreign debts, and so leaves the country. 

Essential Conditions. — This tendency operates only if 
two conditions obtain : first, that there is no scarcity of 
money. A certain amount of money is needed at any time 
for commerce ; if this amount is not forthcoming, then the 
need of money will prevent that hoarding and export of 
" good " money which usually cause its disappearance. 
Governments, by allowing no free coinage and by regulating 
the amount of money in circulation themselves, instead of 
leaving it to be determined by the production of gold and the 
action of banks, can make almost any kind of money circulate ; 
such regulation is, however, a delicate and difiicult business 
owing to the constant change in the need for money, due to 
trade-fluctuation, and still more to the fact that trade is not 
confined within the boundaries of the State, while the au- 
thority of the Government is so confined. The second 
condition is that the " bad " money actually circulates. If 
the business community refuse to have anything to do with 
it, as the people of the Pacific States did with the greenbacks 
of the Federal Government during the Civil War, the issue 
of the " bad " money will not affect the circulation of the 
*' good." 



Money 163 

IV 

Paper Currency 

Inconvertible Paper. — There are many substitutes for 
metallic money. The first is inconvertible paper currency, 
which has sometimes been called " fiat " money. It is made 
by the mere statement by a Government that such and such 
a piece of paper is such and such an amount of money. Some- 
times the statement takes the form of a promise that payment 
in metal will be made ; since the promise is indefinite, and 
is not intended to be fulfilled, the difference of form is unim- 
portant. Such money is put into circulation by the Govern- 
ment using it to pay its debts. It circulates because the 
Government forces its debtors to accept it, and authorizes 
them to settle their debts with it also. Such money, as 
Ricardo pointed out, is simply money with a seigniorage of 
100 per cent. In the long run the Government does not 
make all profit, since the money comes back to it in payment 
of Government dues and taxes. The danger of the issue of 
such money is that it will be overissued — i.e. issued in excess 
of the needs of the community for a medium of exchange. 
The temptation to overissue is strong, since the only expense 
of producing the money lies in the cost of paper and printing, 
and it is extremely difficult to estimate what amount is 
needed. Trade fluctuates, and with it the demand for money, 
so that even if the paper originally issued was no more than 
sufficient to meet current requirements, it will become ex- 
cessive when trade falls off. If the Government that issued 
it is not very stable, there is additional obstacle to its circu- 
lation, and its purchasing power may fluctuate with the 
fortunes of the Government, as the greenbacks did with 
the fortunes of the Federal Army in the Civil War. It is 
an inelastic currency, since the supply of it, though easily 
extended, is not easily reduced when trade falls off; in this 



-164 Economics for the General Reader 

respect it differs from bank credits, which are to be explained 
later. Once it depreciates, it begins to drive all good money 
out of the country, in accordance with Gresham's Law. 

Examples. — History affords plenty of examples of the 
evils of an inconvertible paper currency money. The notes 
of the French Revolutionary Government called assignats, 
issued on what seemed excellent security, namely the land 
confiscated from the Church, depreciated in comparison with 
metallic money, because the holders of the notes could never 
get hold of the land the notes were supposed to represent, 
and at one time 200 francs in assignats were needed to pur- 
chase the same amount of anything as one silver franc. Eng- 
lish Bank of England notes between 1797 and 1819 were 
inconvertible, i.e. could not be exchanged for gold on demand, 
and depreciated 15 per cent. The greenbacks issued by the 
United States Government to the extent of 450 million dollars 
depreciated at one time 65 per cent, as compared with the 
gold dollar. Such money is no use for foreign pa3anents. 
Its great evil, however, is the uncertainty it introduces into 
business. It neither possesses intrinsic utility nor represents 
anything possessing intrinsic utility; its purchasing power, 
therefore, fluctuates with every change in trade, and no one 
knows what exactly he is being offered when he is offered pay- 
ment in it. The overissue of it by a Government is mere 
robbery, equivalent to the payment of a debt with a check 
that the payer knows will not be honored. 

Bullion Certificates. — At the opposite extreme to in- 
convertible paper currency is the bullion certificate. To 
this class belong the United States gold and silver certifi- 
cates, and, with the exception of about £20,000,000 issued 
against securities, Bank of England notes. They are paper 
documents issued merely to save the trouble of handling large 
amounts of metal ; their convertibility, i.e. the power to 
exchange them on demand for gold, is secured by a 100 per 
cent reserve. 



Money 165 

Credit Note. — A third type of paper money is the bank 
or Government " note." It is a promise or order to pay 
gold or other standard money on demand ; it differs there- 
fore from our first type of paper money in being convertible. 
Unlike the bullion certificate, however, its convertibility is 
not secured by the deposit in reserve of gold to the same 
amount as the issue of notes ; a reserve of gold is kept, but 
not a 100 per cent reserve. The bank or government that 
issues notes knows from experience that not all the notes 
will ever be presented for cash payment at once ; it main- 
tains a cash reserve against them, therefore, sufficient only 
to pay cash for so many as are likely to be presented. These 
notes — they will be dealt with again in the next chapter as 
forms of credit — are a currency created in Europe chiefly 
by banks, in the United States by Government as well as 
banks. They have the quality of general acceptability, be- 
cause, although they have themselves no intrinsic value, they 
are convertible, i.e. can be exchanged on demand for gold. 
They represent a great economy in the use of gold, since 
the gold reserve required as the basis for a note issue is 
only a fraction of the amount of the issue. This econ- 
omy, however, introduces a risk which is not present in 
the case of bulHon certificates ; this risk is the simul- 
taneous presentation for cash payment of an amount of 
notes greater than the cash reserve. If this happens, the 
bank must fail, even if it have other assets to more than the 
value of the demands upon it, since a presented note is a legal 
demand for cash, not for any kind of property. The same 
danger may be put in another way : the bank may not keep 
an adequate reserve, i.e. an amount of cash or bullion sufficient 
to meet the possible demand for cash. The bank has sufficient 
motive to keep its reserve adequate, in the obligation which 
it is under to pay cash on demand for its notes ; but the profit 
made by increasing the note issue without increasing the 
reserve is a motive tending to action in the opposite direction. 



1 66 Economics for the General Reader 

Checks. — In England any additional issue of bank notes 
was stopped by the Bank Act of 1844, and the check has 
taken the place of the note as the chief form of currency. 
A check is an order on a bank by some one who has a credit 
with the bank to pay cash to the person mentioned in the 
order. Its acceptability is secured by the same means as 
that of the note, namely by its convertibility ; and its con- 
vertibility is secured similarly by the bank's cash reserve. 
The check has several advantages over the note. It enables 
a payment involving fractions of a dollar to be made without 
the use of small change; only amounts which are multiples 
of one dollar can be paid by note. A check if drawn to order 
not bearer, must be indorsed by the payee, and the indorse- 
ment is a receipt of payment. In England they have the 
system of " crossed " checks under which, if the check be 
crossed (that is if two parallel lines be drawn across the face 
of the check), the bank on which it is drawn will pay the cash, 
which the check orders them to pay, into a banking account 
only ; thus the payer has a check on the movement of his 
payment, and can transmit it by post without fear of its 
being misappropriated. Finally, every check goes through 
the signatory's bank, and the bank keeps account of all checks ; 
hence the signatory's payment account is automatically kept 
for him : by passing his receipts as well as his payments 
through his banking account, he can have all his accounts 
kept for him. The check, however, does not circulate quite 
so freely as the note; its acceptability is not so general. 
This is due to the fact that its value depends on the solvency 
of the signatory to it, while a note has the credit of a well- 
known bank behind it. Also the payer of a check cannot 
pass on a better title to it than he has himself; if A steals 
a check and uses it to pay a debt he owes B, the amount of 
the check can be recovered from B on discovery of the theft, 
while if A steals a bank note and pays it to B who receives 
it in good faith and spends it again, the owner of the note 



Money iGy 

cannot recover from B. In spite of these slight drawbacks 
the use of the check is growing more rapidly than that of 
any other medium of exchange. 

Bills of Exchange. — The only other substitute for metallic 
money that is of importance is the draft or bill of exchange. 
A bill of exchange is difi&cult to distinguish from a check, 
but usually looks to the future and may be drawn not on a 
bank but on a merchant. Its typical form is : 

$5000 

New York, 
To White, Jones and Co. March i, 1918. 

Three months after date pay to the Victor Manufacturing Co., or 
order, the sum of five thousand dollars, for value received. 

(Signed) Victor Manufacturing Company. 

J. M. Bell, PREsmENx. 

In this example, the Victor Manufacturing Co. are said to 
" draw on " White, Jones & Co. The Victor Manufacturing 
Co. will draw up the form and send it to White, Jones & Co. 
If the latter admit their liability, they will " accept " it, i.e. 
write across it " accepted, White, Jones & Co." ; they thereby 
make themselves liable to pay cash to the amount of $5000 
onJunei,i9i8. The Victor M anuf acturing Co . can then either 
wait till the full three months have elapsed and then collect 
payment, or they can take it to a bank or bill-broker, who 
will " discount " it, i. e. give them cash for it, less interest for 
three months ; or they can use it to pay a debt to some other 
creditor. In either of the last two cases they will have to 
indorse the bill, thus making themselves liable to pay it 
when due, if the firm on which it is drawn is unable to meet 
its liabiUty. A bill of exchange may be used to settle a dozen 
debts and travel half round the world ; each firm that uses 
it to pay a debt will indorse it, making itself liable to meet 
it when it falls due, if none of the firms whose names appear 
earlier on it is able to do so. The phrase " for value received " 
should be noticed. Usually it is true ; the bill is a payment 



1 68 Economics for the General Reader 

for goods which have been sent by the drawer to the drawee, 
and the bill is almost equivalent to an invoice. Sometimes, 
however, the phrase is a mere form ; the bill is then a device 
for making a loan, and is known as a Finance Bill or Accom- 
modation Bill. 



CHAPTER X 
BANKING AND CREDIT 



The Canceling of Indebtedness by the Use of Credit- 
Instruments 

Economy of Paper Substitutes. — We have seen that the 
use of money is a device to facilitate exchange. We have 
seen that the one quality essential in money is acceptability, 
and that the easiest way to give money that essential quality 
is to use as money a commodity acceptable and valued on 
account of its intrinsic properties. United States gold coin 
is money of this kind, " and is acceptable everywhere, 
because its value depends not on the government stamp 
upon it, but on its material. The use of such money to the 
exclusion of all other kinds is, however, impracticable, the 
amount and frequency of commercial exchanges being too 
great for them all to take place through the medium of gold. 
Consequently certain paper substitutes for cash have come 
into use, which save society the labor which would be re- 
quired to extract from the earth a store of gold large enough 
to serve as the medium for all exchanges. Cash is expensive 
to society ; all the kinds of paper money we have examined 
economize cash. We have now to proceed beyond a bare 
description of them, and inquire how they effect this economy 
of cash. 

Basis of Value. — It should be noticed first of all how the 
essential quality of acceptability is secured for paper money. 

169 



170 Economics for the General Reader 

In the case of inconvertible paper money issued by a govern- 
ment, or with the authority of a government, acceptability 
is secured by law ; by law the paper is legal tender, the offer 
of it must be accepted as full settlement of debts. This 
method is unsatisfactory, since, as we have seen, this method 
cannot be relied on to secure for the paper acceptability at 
par, i.e. acceptability at its nominal value measured in gold. 
In the case of all other kinds of paper money the quality of 
acceptability is secured by making them " convertible," 
i.e. exchangeable for gold. Bank-notes, checks, and bills of 
exchange are not gold, but they are all promises to pay gold ; 
they give their holder a claim to gold, and on the whole, there- 
fore, enjoy the same acceptabiHty as gold itself. 

Cancellation. — Now if sellers who had received pay- 
ment for their goods in these paper claims invariably demanded 
the gold which these papers entitled them to claim, there 
would be no economy of gold ; payments would be deferred, 
but would still be gold payments. The reason why these credit 
instruments economize gold is that they are not as a rule 
presented for payment in this way; they are transferred 
from one person to another until the claims which a man 
creates against himself by buying and the claims which he 
acquires over others by selling are brought together and can- 
celed, the difference only, and usually not even that, being 
paid in gold. 

Methods of Cancellation. — This canceling may be effected 
in any of several ways. Suppose Adams, a farmer, sells all 
his butter to the village storekeeper, Brown, and also buys 
from Brown all his groceries. Brown will not hand cash 
over to Adams every time he receives a consignment of 
butter, he will instead make a note of the value received; 
and Adams will not pay Brown cash every time he takes 
from the store a pound of tea, instead he will tell Brown to 
put it down in the account. Once a month or once a quarter, 
a balance will be struck; Brown will find, perhaps, that he 



Banking and Credit 171 

has received $125*3 worth of butter and sold $icx)'s worth of 
groceries ; he will cancel the $100 of his claim on Adams 
against $100 of Adams' claim on him, and need hand over 
in actual cash only the balance, $25. 

Suppose again that the larmer Adams instead of selling 
his butter to Brown, from whom he got his groceries, sold it 
to a produce dealer, Clark, who was Brown's landlord ; then 
there might be a similar elimination of cash-dealings by the 
canceling of debts. Adams owes Brown $100 for groceries, 
Brown owes Clark $100 for rent, and Clark owes Adams 
$125 for butter. Adams instead of giving Brown $100 
gives him a promissory note of some kind for the amount, 
intending to meet the note when Clark has paid him for 
his butter ; Brown induces Clark to accept the note in 
settlement of his rent, and Clark hands it over with $25 
to Adams in payment for the butter. Thus exchanges to 
the amount of $325 will have taken place and only $25 have 
been transferred. 

Cases as simple as this are not likely to occur often; but 
the case illustrates the possibility of economizing gold by 
a system of canceling the debts which a man incurs by 
buying against the claims he acquires by selling. The diffi- 
culties in the way of a general use of this simple system of 
carrying on exchange are three : Adams' business may 
be perfectly solvent and yet his name be unknown. In that 
case, bills or drafts drawn on him will not have the quality 
of acceptability once they get outside the immediate circle 
of his acquaintances. Secondly, Adams' creditor may have 
perfect faith in Adams' ultimate solvency, and yet doubt 
his ability to produce at a moment's notice the cash which 
the note is a promise to pay. If he is likely to want cash 
himself, therefore, he will refuse Adams' note (politely, one 
hopes) and insist on currency. The third difl&culty is this : 
modem commerce is extremely complicated, specialization 
is carried so far that every business man has relations with 



172 Economics for the General Reader 

great numbers of sellers or buyers ; it is extremely unlikely, 
therefore, that the note which Adams successfully launched 
in payment of his grocer's bill will find its way back to him 
in settlement of a claim he has on one of his customers. 

The Bank Account. — The banking system overcomes these 
difficulties. By an arrangement with the bank the business 
man who does not wish to pay gold substitutes a draft on 
the bank (or check) for a draft on himself. This will have 
the acceptability which his draft on himself lacked, firstly, 
because banks are comparatively few in number and their 
names well known over wide areas, secondly, because banks 
undertake to pay cash if cash is wanted. The bank over- 
comes also the third obstacle to the canceling of indebted- 
ness, the obstacle offered by the wide extension and com- 
plexity of modern commerce. The arrangement which the 
business man has with the bank is an " account." This 
account gives him the right to draw on the bank for cash to 
the amount of the account; in other words, it is a claim to 
cash which the bank will recognize and which he can transfer. 
Now Adams, Brown, and Clark in our imaginary instance 
would all have banking accounts. Adams, therefore, would 
pay his quarterly grocery bill to Brown not with a draft on 
himself but with a check. Now, a check is an order on 
the bank to pay gold, but the receiver of a check rarely 
exercises his right to demand gold, being content to pay 
the check into his own banking account. Brown, there- 
fore, would pay Adams' check into his account, and the 
bank would credit his account with an additional $100, at 
the same time deducting $100 from the amount standing 
in its books to Adams' credit. Similarly Brown would 
pay Clark with a check, and Clark would pay Adams with 
a check, the receiver in each case paying the check into his 
account. Thus Adams' banking account would be increased 
by the amount of his sale of butter, $125, and decreased 
by the amount of his purchase pf groceries, $100; Brown's 



Banking and Credit 173 

banking account would be increased by the amount of his 
sale of groceries and decreased by the amount of his rent ; 
Clark's account would be increased by the payment he re- 
ceives from his tenant and decreased by the amount of his 
purchases of butter. Each has paid for his purchases, not 
with gold nor with a claim on himself, but by transferring a 
portion of the claim on the bank which his account gives 
him ; each is paid for his sales in the same way. Thus at 
the hank the claims which each acquires over others by his 
sales and the claims which each gives others on himself by 
his purchases are brought together, canceled so far as they 
balance each other, and the difference credited or debited 
to the account of each; in our instance, at the close of the 
series of exchanges, Adams' banking account will be $25 
higher than it was at the start, Clark's $25 less, Brown's 
as it was. 

Inter-Bank Relations. — It may happen, however, that 
there are two banks in the village, and that Adams has his 
banking account at a different bank from the other two; 
we will call Adams' bank the First National and the other 
the State Bank. Adams will then pay Brown with a check 
on the First National which Brown will pay into his account 
at the State Bank ; this check will give the State Bank a 
claim for $100 on the First National, since it is an order 
on the First National to pay Brown or his representative 
$100. Clark, on the other hand, will pay Adams with a check 
on the State Bank, which Adams will place to his account 
at the First National ; this check gives the First National 
a claim to $100 from the State Bank, and it is merely necessary 
for the representatives of the two banks to meet for these 
contrary claims to be set against each other and the balance, 
$25, paid by the State Bank to the First National. The 
principle is exactly the same as in the previous case ; pay- 
ment is made by the purchasers transferring to the sellers 
claims on their banks, and the banks, being in touch with 



174 Economics for the General Reader 

one another, can bring opposing claims together and cancel 
them. Even if the two banks are in different districts, the 
same result will be brought about. While we have in the 
United States more than 25,000 independent banks and trust 
companies, all are connected, through membership in the 
Federal Reserve system or through correspondents in New 
York, in a gigantic clearing system. Checks on member 
banks in the same federal reserve district are cleared through 
the reserve bank of the district. If they are drawn on member 
banks outside the district or on non-member banks that have 
joined the reserve system's " country-wide " check collec- 
tion organization, they are cleared through the gold settle- 
ment fund at Washington established to handle the items 
arising between the reserve banks themselves. When 
checks are drawn on non-member banks not enrolled in the 
reserve system's clearing organization, the balancing of the 
reciprocal claims arising between different communities is 
effected through the remittance of drafts on New York or 
on other large centers where transfers are made from one 
account to another on the banks of the correspondent banks. 
Currency shipments are only occasionally necessary to re- 
plenish or to draw down balances. 

Through the complex and far-reaching banking system 
the claims to cash which a man is constantly acquiring by 
selling his goods or his labor can be brought together and 
balanced against the claims which others are constantly 
acquiring on him by selling to him goods or services, so that 
he needs cash only for purposes of retail transactions. The 
banking system is a great clearing-house, in which sales and 
purchases are registered and thus canceled against each 
other. Banking systems, however, are national, not inter- 
national; there remains for consideration the case of inter- 
national exchanges. These are effected chiefly through the 
medium of the bill of exchange. The note which we im- 
agined the farmer Adams giving to his creditor Brown was, 



Banking and Credit 175 

in effect if not in form, a bill of exchange ; it was an under- 
taking to pay cash for value received at some future date. 
Brown used it to pay Clark, and Clark to pay Adams. Be- 
tween the date when a bill is drawn and settles the first 
debt, and the date when it falls due and is presented for 
cash-payment, it may be used a score of times to settle a 
score of debts, perhaps in half a dozen different countries. 
Bills of Exchange as Instruments of Cancellation. — Bills 
of exchange are used in internal trade, but they arose in inter- 
national trade and are the most usual method of making 
foreign payments. Suppose that an American merchant is 
buying English cloth to the value of $500 at the same time 
as a London merchant is buying American wheat to the 
value of $500. It would be a great waste of trouble 
if the American merchant shipped $500 across the Atlantic 
to pay the English manufacturer, and at the same time 
the English corn-merchant shipped $500 to pay the Ameri- 
can wheat-exporter. That trouble is saved by the Ameri- 
can wheat-exporter drawing a sterling biU on the English 
corn-merchant and selling the bill for dollars at the 
current buying rate for sterling quoted by his banker. 
The English corn-merchant accepts the bill, paying it at 
maturity. On the other hand, the American cloth im- 
porter purchases from his banker a sterling draft drawn on 
the banker's London correspondent. This draft is mailed 
to the English exporter, who deposits it and has it credited 
to his account. Thus through the medium of bills of ex- 
change the English manufacturer's claim on the American 
cloth importer is exchanged for a claim on a London grain 
dealer, and the American exporter's claim on the London grain 
dealer is exchanged for a claim on an American cloth importer ; 
both collect payment at home, and no cash crosses the Atlantic. 
In practice the American exporter will not draw on the English 
grain dealer, but on some financial house that makes a busi- 
ness of creating bills. The English grain dealer may be quite 



176 Economics for the General Reader 

solvent and yet his name be unknown; a bill drawn on him 
might be a good bill and yet be unacceptable simply because 
he was not well known, so that the American exporter when 
he got the bill would be unable to use it ; the primary essen- 
tial of currency is acceptability, and his bill would lack that 
quality. The difficulty is got over by the English grain 
dealer making an arrangement with a financial house ; they 
know him, and they themselves are known everywhere; 
a bill on them will be acceptable, because they are known. 
The American exporter, therefore, draws on them, the EngHsh 
grain dealer giving them security against loss and paying 
them for the use of their name. The principle of the trans- 
action is the same as in payment by check. The purchaser 
who pays with a check transfers his claim on a bank to his 
creditor; the purchaser who pays with a bill on a discount 
merchant, transfers the claim on this discount merchant 
which he has acquired by giving him security and paying 
for the use of his name. In England financial houses that 
create bills of exchange are frequently firms originally engaged 
in general merchandising, who found that their reputation 
was so good that they could literally " trade upon it " by 
selling bills of exchange drawn upon them. 

The net result of the use of checks and bills of exchange 
is to substitute an institution — the Money Market, which 
includes banks, discount merchants, and bill-brokers — for 
a commodity — gold — as the medium of exchange. If I 
have textiles for sale and I want grain, I do not exchange my 
textiles for gold and the gold for grain ; I exchange the textiles 
for a claim on a bank, and the claim on the bank for grain ; 
gold is eliminated as the medium of exchange (though it 
remains the standard of value), and the institution comes in. 
The man to whom I give my textiles says the bank will pay 
me. He transfers his claim on the bank to me, and I tell 
the man from whom I get the corn that my bank will pay 
him. I transfer my claim on the bank to him. If every' 



Banking and Credit 177 

body always used this method of negotiating exchanges, there 
need be no gold; all purchases and all sales would be registered 
in some bank, so that a man's sales could always be set against 
his purchases. But somebody always and everybody some- 
times wants the gold or currency, to which the check, note, 
or bill gives a claim. Hence banks have to keep a reserve 
of gold, and gold remains the basis of all exchange. 

II 

The Creation of Credit by Banks 

The Functioning of the Bank Account. — We have seen 
that most payments in wholesale commerce to-day are made 
not in gold but in promises to pay gold or in credit instru- 
ments that constitute a claim to gold. The man who sells 
goods receives a check or bill which gives him a claim to gold ; 
the man who buys goods pays with a check or bill which 
represents a claim to gold. We have seen that in the banking 
system all claims of this nature are brought together, all 
sales and purchases are, as it were, registered, so that the 
claims against a man (on account of his purchases) may be 
set against the claims he has on others (on account of his 
sales), and the balance only paid to him or collected from him. 
For a claim on himself the purchaser by arrangement sub- 
stitutes a claim on his bank or some well-known financial 
house, i.e. he pays with a draft, not on himself but on the 
bank (a check) or on the financial house (a bill of exchange). 
He is paid with similar checks and bills, most of which he 
pays into his banking account. Thus, in his banking account 
the claims which his sales give him against others are set 
against the claims which his purchases give others against him. 

Methods of Obtaining Accounts. — This " arrangement," 
by which the purchaser is able to give a draft on a bank 
instead of allowing his creditor to draw on him, is called a 



1 78 Economics for the General Reader 

" banking account." An account may be created, either 
by the client paying in something to the bank or by the bank 
making an advance to the client. In the first case the cHent 
places in the bank's keeping a portion of his wealth, which 
the bank is at Hberty to use as it thinks fit, so long as it can 
return his wealth on demand or due notice ; in return for 
the use of his wealth the bank will either pay him interest 
or transact his banking business for him without making 
any charge for the service. In the second case, in return 
for the payment of interest, the bank treats a client, who 
has not given the bank his wealth to use, in exactly the same 
way as it treats a client who has. What the banker in effect 
says to his chent is, " Give me security and pay me interest, 
and I will pay your debts for you in precisely the same way 
as I do those of a client who has placed in my keeping a por- 
tion of his wealth for that purpose." The cHent to whom 
a credit is allowed by a bank has to give some sort of security 
for repayment ; but this security differs from the deposit 
against which the holder of a deposit account can draw 
checks, inasmuch as the bank cannot use it in any way ex- 
cept as security. If, for example, I deposit five hundred 
dollars with a bank, the bank can immediately lend them to 
somebody else ; if I receive a credit of $500 and give as se- 
curity my life-insurance policy, the bank can do nothing with 
that, so long as I satisfy the conditions on which the credit 
was granted. But whether a bank's client has acquired 
the right to draw checks on the bank by depositing wealth 
with the bank or by receiving an advance from it, he has that 
right; the bank undertakes to honor checks signed by him, 
i.e. to pay cash for them if asked to do so. An account 
which gives this right to draw checks, however acquired, is 
a " Demand deposit." Banks will also receive money on 
deposit and pay interest on it, on condition that it is not 
withdrawn without the giving of some days' notice; an 
arrangement of this kind is a " Time deposit." 



Banking and Credit 179 

The Clearing House. — Suppose a bank has made an 
advance of this kind ; the bank's client will wish to use the 
advance, and will use it by drawing checks to the amount 
of the advance to pay his creditors. Now his creditors in 
nine cases out of ten will not cash these checks, but will pay 
them into their banking accounts as deposits; thus the ad- 
vance made by one bank becomes a deposit in another bank, 
or, it may be, in the same bank. If the creditor to whom 
the bank's client pays the checks which he draws against 
his advance has an account with the same bank, the bank 
has merely to make two entries in its books, deducting the 
amount of the check from one account and placing it to the 
other ; if the checks are paid into some other bank, they will 
be set against checks drawn on this other bank and paid into 
the first bank, when the representatives of the two banks 
meet in the Clearing-House. Thus while deposits or advances 
are distinct from the point of view of the individual client or 
bank, from the point of view of the banking system as a 
whole deposits and advances are largely identical. 

Credit Extension. — We can see now how banks are able 
to " manufacture credit," we might almost say " manu- 
facture money." At first they accepted deposits of gold and 
loaned them out again, acting merely as middlemen between 
those who had and those who wanted cash. Now they 
accept deposits which they loan out again, and in addition 
make advances which have no deposits against them, by creat- 
ing claims on themselves which their clients can transfer 
in payment for their purchases. The bank makes an advance 
to a client of $5000 ; this means that it undertakes to meet 
the claims for gold on its client to the amount of $5000 ; 
it has increased its liabihties by $5000, and this will appear 
in its balance sheet in the form of an additional $5000 added 
to its Demand and Time Deposits, while there is a corre- 
sponding increase in its assets appearing in the balance 
sheet in the form of $5000 added to its Loans and Discounts. 



i8o Economics for the General Reader 

When a bank makes an advance of $5000 a mutual liability 
is created between the bank and its client ; the bank incurs 
a liability to find $5000 in cash if called on, and the client 
incurs a liability to repay the bank $5000 when called on. 
The bank can incur this liability only because it is never 
called on to meet it in full; the clients to whom it makes 
advances draw checks against those advances to pay their 
debts, but the checks are never all presented for cash pay- 
ment; most of them always are paid into other banks as 
deposits and are canceled against checks on these other 
banks, which are paid into the first bank as deposits. A 
bank can safely make advances because those advances will 
most of them become deposits in other banks, just as its 
own deposits consist largely of claims on other banks which 
have made advances to their clients. 



Ill 

The Cash Reserve 

Function of Reserve. — Are there any limits to this power 
that banks have of " manufacturing credit," and so increasing 
the amount of currency? It is obviously profitable to them, 
since their clients pay them interest on these check credits 
in precisely the same way as they would if the loan consisted 
of other clients' deposits, on which the bank was paying 
interest itself. There are limits. The extreme theoretical 
limit is the amount of security which the cHents have to 
offer for advances; since, however, banks will sometimes 
make an advance simply on the security of a client's good 
name, this extreme Hmit is vague and practically unim- 
portant. The real limit is imposed by the need of keeping 
a cash reserve against the liabilities involved in all accounts, 
credit as well as deposit accounts. Any one with an account 
at the bank can draw checks, and a check is an order on the 



Banking and Credit i8i 

bank to pay gold (or other forms of money equivalent to gold), 
which the bank undertakes to honor. Usually a check drawn 
on one bank is paid into another bank and simply canceled 
with a check drawn on the second bank and deposited with 
the first. If people were always content to trust the bank, 
and to make and receive all payments by check, then banks 
need keep no cash reserve. But everybody at some time 
needs cash. The demand for cash, or, to put the same thing 
in another way, the extent to which people will be satisfied 
with payment by check or other credit instruments, varies, 
so that the cash reserve which a bank needs varies also ; 
but an adequate cash reserve the bank must keep. A check 
is an order to pay cash. A glance at a bank's balance-sheet 
will show that a small proportion only of its assets are cash, 
yet none of the other assets will serve instead of cash, if there 
is anything in the nature of a " run " on the bank ; checks 
cannot be met by the offer of investments, the securities 
held against advances, bank buildings, or any of the other 
assets, and in such a time it may be impossible to call in loans 
or to realize any of the assets, except at a heavy loss. It 
is essential, therefore, that a bank keep a cash reserve ade- 
quate to meet all the demands for cash that will be made by 
clients who have deposits with or advances from the bank ; 
it is almost as essential that the bank keep its assets " liquid," 
i.e. invest its resources in such a way that they are not " locked 
up " and can be converted into cash at short notice. 

Conflict of Motives in Reserve Management. — Here is 
the banker's dilemma. By keeping a large cash reserve in 
proportion to his Habilitics, he will secure safety; but he 
will reduce his profits, since the cash reserve earns him no 
interest, and he may embarrass his cb'ents, who rely on him 
for advances and may be seriously inconvenienced, perhaps 
even driven into bankruptcy, if he contracts his credits in 
order to strengthen his reserve. If, on the other hand, he 
keep a small reserve, freely giving his clients the advances 



i82 Economics Jor the General Reader 

they ask for and increasing his profits by reducing the pro- 
portion of his assets lying idle, then he will be jeopardizing 
security; in case of a collapse of confidence in the business 
world, he will be unable to meet the demands for cash made 
upon him, and may involve in his ruin many of his clients 
who had relied on him to supply them with cash. 

Regulating Reserves. — It is not the amount of the cash 
reserve that is the important thing in banking, but the pro- 
portion of cash reserve to liabilities, i.e. to outstanding notes 
and deposits ; it would be a futile precaution to fijs the amount 
either of reserve or of advances. And the proportion which 
the reserve must bear to the liabilities is not fixed ; it varies 
with the state of confidence in the money market and the 
needs of business. A credit system is a system based on 
trust; when business men have no reason to distrust one 
another's ability to pay cash, they will not insist on cash and 
will be content with promises to pay cash, i.e. credit instru- 
ments; when they have reason to be distrustful, they will 
want cash. When credit is good, " credits " may be increased ; 
when credit is bad, " credits " must be reduced — in other 
words, the proportion which the cash reserve bears to the 
liabilities to find cash must be increased. 

United States. — In the United States reliance has long 
been placed on legally prescribed reserves. Before the or- 
ganization of the Federal reserve system the prescribed 
reserves were criticized because they were rigid, that is to 
say the law required their maintenance irrespective of cir- 
cumstances. In the formulation of the Federal reserve 
system, however, the attempt was made to make credit 
responsive as well as secure. 

The cash reserves of the American banking system are 
variously prescribed for the different classes of banks and for 
the two forms of bank credit, namely, deposits and bank 
notes. The Federal reserve banks, of which there are twelve, 
are required to maintain a 2,S P^^ cent reserve in gold and 



Banking and Credit 183 

lawful money against their deposit liabilities which are mainly 
banker's balances regarded by the bankers themselves as 
the equivalent of cash in their own vaults. All banks members 
of the Federal reserve system are required to keep reserves 
of 13 per cent, 10 per cent, or 7 per cent according as they 
are situated in central reserve cities, reserve cities, or in smaller 
places. On the other hand the reserve requirements for 
bank notes vary. National bank notes and federal reserve 
bank notes which are based upon government bonds have 
behind them no special cash reserve beyond a 5 per cent 
specie reserve deposited as a special redemption fund with 
the government. Federal reserve notes, based on com- 
mercial paper acquired by the Federal reserve banks, are 
required to have a forty per cent reserve in gold. Under 
the Federal law, however, the Federal Reserve Board is author- 
ized under adequate safeguards to suspend reserve require- 
ments for a period of thirty days and to renew the suspension 
for periods of fifteen days. The power thus accorded to the 
Board lifts the charge of rigidity formally leveled at the 
national reserve requirements. 

Banks organized under the laws of the several states are 
subjected to various reserve requirements. State laws vary 
not only with respect to percentages, but also with respect 
to location and composition. Note issue by State banks, 
while legal in a good many cases in so far as charter rights 
are concerned, are rendered practically impossible through a 
federal 10 per cent tax. 

England. — English banks keep no fixed proportion of 
cash reserve to liabilities, and seldom keep a 25 per cent 
reserve; but by strengthening their reserve in anticipation 
of any unusual call for gold they have been able for over 
a generation, except during the crisis precipitated by the 
Great War, to meet all demands on them. The cash reserve 
of the English banking system as a whole is probably smaller, 
in proportion to liabilities to find cash, than is the case in 



184 Economics for the General Reader 

any other country, and the reserve is concentrated at a 
single point in a way that is not found elsewhere. The other 
banks keep the greater part of their reserves in the form of 
a deposit with the Bank of England. They do this (although 
the bank pays no interest on such deposits) partly because 
the Bank of England has facilities which the other banks 
lack for safeguarding large amounts of bullion, partly in order 
that they may be able to pay one another clearing-house 
balances in checks on the Bank of England. Now the Bank 
itself, in addition to acting thus as the banker's bank, does 
an ordinary banking business, and therefore loans out its 
deposits to customers, discounts bills of exchange, and makes 
advances on other security, keeping only a proportion of 
its assets in cash or bullion. It keeps a much bigger cash 
reserve in proportion to its liabilities than any other bank; 
still the other banks treat their deposits with the Bank as 
equivalent to cash, so that the reserve which the banks state 
that they are keeping against their liabilities is not altogether 
a cash reserve ; the Bank of England's own banking transac- 
tions reduce still further the amount of actual cash kept as 
a reserve against the liability of all banks to pay cash, if 
called on, to the amount of their current and deposit ac- 
counts. 

The law has permitted yet a further deduction ; the Bank 
Charter Act of 1844, while forbidding the issue of notes ad- 
ditional to the notes already in circulation except against an 
equivalent deposit of coin or bullion, permitted the Bank to 
issue £14,000,000 against securities.^ The Bank is in two 
departments, a Banking Department and a Note Issue De- 
partment; the Banking Department places all gold that 

^ This amount has since been increased to £18,450,000 by the provision in 
the Act that when a bank with the right to issue notes lost that right by amalga- 
mation with a London bank, or any other cause, the Bank of England might 
increase its note issue against securities by two thirds of the amount of the 
lapsed issue. 



Banking and Credit 185 

comes to it in the Note Issue Department, taking out notes 
in exchange. Thus the " cash " reserve of the Banking 
Department is a reserve of notes, and of these notes some 
twenty millions are issued against securities, not against gold. 
The credit system of England is like a pyramid, the apex of 
which is the gold reserve ; but the pyramid rests not on its 
base, but on its apex, and the balance of it depends on the 
judgment of the managers and directors of the banks that 
compose it, above all on the judgment of the directors of the 
Bank of England. 

English bankers are not required by law to maintain any 
definite proportion between their cash reserve and their 
liabilities. This system is defended, as against the system of 
a legal minimum, on the grounds that it is both more econom- 
ical and safer ; more economical because it permits a re- 
duction in the cash reserve lying idle, when the temper of 
the money market is confident; safer, because it throws on 
the banker the full responsibility of maintaining an adequate 
reserve, so that he will be constantly anticipating changes 
in the market with a view to strengthening his reserve before 
the need comes, instead of relying on a statutory 20 per cent 
or 25 per cent reserve. This constant anticipation of the 
demand for cash, and variation of the reserve in accordance 
with it, is the most important part of the banker's work, 
and controls English banking policy. In England a banker 
is expected to keep his assets liquid, in order to protect his 
reserve. 

A distinguished banker once said that the art of banking 
lay in being able to distinguish between a Bill of Exchange 
and a Mortgage, because a Bill of Exchange is the chief 
example of a liquid asset, while a Mortgage locks up one's 
money for a long term of years. A bank's assets, as stated 
in a balance-sheet, illustrate this principle. First comes 
" Cash in vault or on deposit with Federal Reserve Bank," 
essential to the banker's work because needed to meet demands 



i86 Economics for the General Reader 

for cash, but a comparatively small proportion of the whole 
because earning the bank no interest. Next " Demand " 
or " Call Loans " ; these are advances to brokers and specu- 
lators, at a low rate of interest in consideration of the fact 
that the bank can insist on repayment on demand. Next, 
the most important item, " Loans and discounts." The 
loans are made on some security and, being made for a def- 
inite term, take the bank's assets out of its control only for 
that term. Discounts are really only a special kind of " loan." 
A client of the bank, having sold goods to a customer in an- 
other country, has been paid with a bill due, say, in three 
months ; he wants the money at once, and goes to the bank, 
which takes the bill from him at its face value less three months' 
interest or discount. The transaction is really a loan on the 
security of the bill, since the client will have to indorse the 
bill, thus making himself liable to meet it when it becomes 
due, if the person on whom it is drawn does not do so; at 
the same time it is just the kind of investment the bank 
wants, since it is secure — the goods should have reached 
the foreign customer, been sold, and provided him with the 
money to meet the bill by the time the three months have 
elapsed — and it ties the bank for three months only. Next 
come " Stocks and Bonds," earning for the bank a good rate 
of interest, but a comparatively small proportion of the whole 
assets because they are of little use in times of stringency for 
strengthening the reserve. Last come " Banking House and 
Fixtures," a small item. 

Strengthening Reserves. — The method by which a bank 
protects its reserve will be clear from this consideration of its 
assets. The banker will watch all the signs of the market, 
and, if he anticipates a demand for cash, will restrict his 
loans and discount fewer bills. Meanwhile loans made pre- 
viously will come to the end of their term and bills held by 
the bank will fall due, so that the banker will be acquiring 
" claims to cash " to set against the claims which the bank's 



Banking and Credit 187 

depositors have on the bank, and thus the proportion which 
the cash reserve bears to the outstanding liabihties is in- 
creased. The restriction of credit must not be done suddenly ; 
so many businesses are dependent on advances from banks 
that a sudden withdrawal of these advances by the banks 
would precipitate many into bankruptcy and perhaps pro- 
duce a financial crisis. The device by which a gradual and 
safe restriction is effected is the raising of the rate of interest 
charged for loans and the rate of discount charged on bills. 
By this device those who can possibly do without the bank's 
assistance will do so to avoid the expense of the higher rate 
of interest, while those who must have the assistance will 
be able to get it by paying for it. 

Under the Federal Reserve System a member bank, un- 
able because of inadequate reserves to extend further credit, 
can by rediscounting acceptable commercial paper or by offer- 
ing prescribed collateral with its own note obtain advances 
from its reserve bank. These advances are added to the 
member bank's balance and permit it to extend such further 
credit as circumstances require. A general resort to the re- 
serve banks for advances of this kind enables the reserve banks 
to control the discount and interest rates that the member 
banks themselves quote on the theory that no member bank 
will quote a rate lower than it itself has to pay at the reserve 
bank. In England and on the continent of Europe the big 
central banks hold large balances for the bankers and these 
central banks make advances to the other banks for further 
loan and discount operations. Responsibility for protecting 
the home reserves thus devolves upon these central banks. 



i88 Economics for the General Reader 

IV 

The Social Utility of the Credit System 

There remains for consideration the broad question of 
the social utility of this banking and credit system which 
we have been studying. How does it aid production? Is 
it essential to the modern organization of industry or (as 
some think) a useless and dangerous excrescence, main- 
tained merely because so many people are interested in its 
profits? Briefly it may be said that the system is essential 
and fundamental. The principle underlying the whole of 
modern industry is the productiveness of specialization. 
Specialization, we have seen, involves exchange and produc- 
tion in anticipation of demand. The credit system facili- 
tates exchange 2^116. finances production in anticipation of demand. 

Influence on Exchange. — It facilitates exchange. Direct 
exchange or barter is clumsy. The use of a commodity, 
in the form of coin, as a medium of exchange is clumsy ; im- 
agine the amount of gold and silver that would be needed 
if all modern commerce were carried on on a basis of specie 
payments ! The credit system enables us to substitute an 
order on a bank or a bill of exchange, a promise to pay cash, 
for cash itself, and then bring these promises together and 
cancel them. It is a sort of clearing-house, in which a man's 
debts and claims are brought together and set against each 
other. A reserve of gold is still needed, but only a reserve. 
For the commodity, gold, we "have substituted as our medium 
of exchange the institution, the bank. This is the earliest 
function of the credit system; the bill of exchange arose 
centuries before the bank-note, to obviate the necessity of 
shipping bullion to pay for imports ; and early banks, Uke 
the Bank of Amsterdam described by Adam Smith, were 
estabhshed to supply, not credit, but a satisfactory medium 
of exchange. 



Banking and Credit 189 

Influence on Production. — The credit system finances 
production in anticipation of demand. We have seen how 
specialization necessitates production in anticipation of de- 
mand ; it makes the process of production so lengthy and 
roundabout that it has to be commenced months and perhaps 
years before the product will be wanted. Payment, however, 
is not made by the consumer until he receives the finished 
product. When I pay $2.50 for a flannel shirt, I receive 
a finished commodity which the retailer stocked perhaps a 
month ago, the wholesaler perhaps three months ago ; the 
flannel of which it is made was manufactured nine months 
ago out of yarn spun twelve months ago, and the wool 
was grown two years ago ; buildings and machinery were 
required to carry through the different processes of manu- 
facture, coal to drive the machinery, and means of trans- 
port to convey the material from one stage of produc- 
tion to the next. Scores of firms have incurred expenditure 
months and years before I pay $2.50, in order that the shirt 
may be ready. All relied on the ultimate sale of the shirt 
to reimburse them for their expenditure, but the expenditure 
had to be incurred first. The question is, how was this ex- 
penditure met? The woolen shirt is only one transaction 
among millions, on all of which expenditure had to be in- 
curred before payment could be obtained. 

Releasing Funds Tied Up. — The first source from which 
such expenditure is met is current income from shirts already 
sold. The $2.50 I paid for a shirt two years ago may have 
just percolated to the farmer whose wool is in my new shirt ; 
the payment a farmer receives for last year's clip should 
normally meet the expenses of this year's. But many firms 
cannot afford to wait for payment, and all firms at starting 
and at other times have to face periods during which there 
are no incomings to balance outgoings, since their products 
are either incomplete or cannot find a market at the moment. 

Anticipating Funds. — The second source is savings. Each 



1 90 Economics for the General Reader 

person in the series has something in hand when he starts in 
business, with which to buy plant and materials, and to meet 
expenses until the products of the business begin to bring 
in an income. This is the chief resource ; without it special- 
ization to the extent that it is found in modern industry 
could not be adopted. But it does not afford a complete 
answer to our problem, because its usefulness is limited by 
its amount and the number of times it can be turned over. 
For example, a retailer having bought stock would be bound 
to sell out that stock before he could get any new stock — 
even though he might find that something quite different 
was in demand. A manufacturer, having bought yarn and 
woven flannel from it, would have to sell and get paid for 
the flannel, before he could buy any more yarn to continue 
manufacturing. In these cases the difficulty might be over- 
come by the producer spreading his working capital over 
a large number of operations, so that some payments would 
always be coming in ; but the farmer could not do this. The 
farmer gets the greater part of his income at one period of 
the year, when he sells the clip ; if for any reason, such as 
drought, he be forced to incur unusual expenses, and cash 
dealings were the only method of payment, he would go 
bankrupt, although he might have wool and mutton growing 
sufficient to meet all his expenses. Similarly a hop-farmer 
might have all his working capital tied up in a promising 
crop ; the crop is attacked by a blight, but can be saved if 
he can go to the expense of washing it ; if the two resources 
we have dealt with so far were the only resources available, 
he could not save it. And all businesses, commercial and 
industrial as well as farming, would be unable — without 
credit in some form or other — to extend their operations to 
meet a growing demand, except by the slow process of saving. 
The flannel manufacturer, for example, might be absolutely 
certain that he could sell double the quantity he sold last 
year and yet be unable to make more than last year — unless 



Banking and Credit 191 

he can raise money now on the value of his next year's output, 
and with it buy additional yarn, plant, labor, etc. 

This is what the credit system enables him to do. The 
credit system affords, in addition to income and savings, a 
third and most elastic resource from which the expenditure 
incurred in producing ahead of demand can be met. Credit 
is the exchange of '' present " goods for " future " goods. 
On the assurance that you will be able to pay when your 
product is completed and sold, you can borrow now the 
wherewithal to purchase goods now. Notes, bills of exchange, 
and bank credit are the means by which you are enabled 
to do this. The farmer, needing machinery to harvest 
his crop, pays for the machinery with credit obtained at his 
bank ; when the wheat is harvested with the aid of the ma- 
chinery, this advance will be Uquidated. The bank loan 
tides over the interval between the use of the machinery and 
production of the crop. The crop, when harvested, will 
be worth more than enough to pay for the machinery and 
meet all other expenses ; but the machinery is needed to 
harvest the crop. The farmer, therefore, buys the machinery 
with a promise secured on the crop, i.e. exchanges the " future" 
crop for the " present " machinery. The machinery maker 
may carry the farmer on " open account." In that event 
he is likely to discount his own note at the bank. Or again 
the farmer may give the machine maker a promissory note 
which the machine maker indorses and discounts. In either 
case the bank making the discount is really meeting for the 
farmer, until his crop is harvested, the claim against him 
which his purchase of machinery has created. 

Discounting. — Or suppose the wheat is grown and har- 
vested ; an English importer buys it and gives his acceptance 
of a bill payable in three months. He cannot pay cash for 
the wheat until he has sold it himself, and he cannot sell it 
until it has reached England, all of which takes time ; but 
he cannot get it to England, where it is wanted, without 



192 Economics for the General Reader 

giving the fanner something — because the farmer wants 
to get on with his farming, or may have to meet a note which 
he gave in pa3nnent for machinery ; so he gives the farmer a 
promise to pay in three months (by which time he will have 
got the grain to England and sold it) ; the farmer discounts 
the bill, i.e. a bank takes it from him and undertakes to meet 
all claims on him for cash to the amount of the bill (less dis- 
count) ; the bank can wait until the three months have 
elapsed, because it has a cash reserve sufficient to meet any 
claims for actual cash, and can rely on being able to cancel 
any checks drawn on it by the farmer against checks drawn 
an other banks and deposited with it. 

The bill of exchange, which the bank will take, giving to 
the holder in exchange an account subject to his checks, 
is the chief means by which international commerce is carried 
on ; the term of the bill tides the importer over the interval 
between his purchase of the goods in the foreign country and 
the sale of them in his own. The same function is performed 
by the bank if, instead of discounting the bill received by the 
farmer in our last instance, it makes the grain-importer an 
advance. The importer uses the advance to pay for the 
grain, and repays it when he has sold the grain; the bank 
undertakes, this time as before, to meet all claims against 
the value of that grain between the time when it is grown in 
America and the time when it is sold in England. This grant 
of an advance by banks is the most usual method of financing 
production in anticipation of demand. Suppose our flannel 
manufacturer foresees a big demand for tennis flannels ; he 
is already working up to the limit of his capital, but he is 
so sure that additional flannel can be sold that he wishes to 
increase his output. The only way he can do this is to go 
to the bank, convince them that his anticipations are correct 
and also give them security for repayment, and so get a loan 
from them with which to increase his production. He has 
borrowed on the assurance that with the loan he will be able to 



Banking and Credit 193 

produce more, and the increased product will more than re- 
pay the loan; the additional materials, labor, etc., which he 
purchases with the loan are really paid for by, i.e. exchanged 
for, the additional flannel they produce. The banks, with 
their cash reserves and their system of canceling claims for 
cash against each other, can give loans or advances to in- 
crease production in the form of promises to pay cash or 
claims to cash without having to produce more than a small 
proportion of actual cash. In every case the bank enables 
the producer to realize now a portion of the future value 
of his product, and so enables him to produce that product. 

Collateral Security. — The bank enables him to do this 
by taking on itself the responsibility for finding any cash 
that may be claimed from him between the time when he 
commences his part of the productive process and the time 
when he completes it ; the bank can undertake this respon- 
sibiHty, while others cannot, because the bank is the institu- 
tion through which purchases and receipts are brought to- 
gether and canceled against each other, the bank's cash re- 
serve being maintained to meet such demands as there are 
for actual cash. The real security on which a bank relies, 
when it makes the advance to a business man, is the addi- 
tional product which the advance will enable him to put on 
the market ; it requires him, as a rule, to give it other security, 
in case his undertaking prove a failure, but the nature of this 
other security is exactly indicated by its name, " collateral 
security," and it is always a great nuisance to a bank to 
have to sell the collateral security in order to secure repay- 
ment of an advance. Collateral security is Hke the pledge 
left with a pawnbroker for repayment of a loan ; if we did 
not expect to be able to repay the loan, we should sell the 
pledge, not pawn it. 

Summary. — Thus the credit system is needed to finance 
the production in anticipation of demand to which speciali- 
zation leads; and its special function is to give elasticity 



194 Economics for the General Reader 

to the productive organization in response to the constant 
fluctuation in demand. It also has the effect of neutralizing 
to a great extent the irregularity of nature ; it enables the 
fanner to derive from his farm a regular income, month by 
month, instead of receiving his whole year's income in one 
gulp when the harvest comes in and is sold; it does so by 
enabling him to begin to draw on the value of his next harvest 
as soon as the growing of it has begun ; financiers will accept 
bills for him because they rely on his harvest to enable him 
to meet the bills when due. Because the credit system 
facilitates exchange and assists production in anticipation 
of demand, it makes possible the extreme specialization 
which is the chief source of the material wealth of modern 
societies. It is therefore fundamental to modern industry, 
in the same way and to the same degree as are the means of 
transport ; it developed as they developed, and, though its 
working is not so obvious as are bridges, embankments, and 
docks, it is as important. 



CHAPTER XI 

THE le\t:l of prices and foreign exchanges 

I 

The Measurement of Changes in the Level of Prices 

Significance of the " Level of F*rices." — A price is the 
amount of money for which a commodity exchanges in the 
market. Since most commodities are exchanged for money, 
money becomes the standard of value ; instead of saying that 
a bicycle is worth thirty bushels of wheat, we say that the 
bicycle is worth $30 and wheat is worth $1 a bushel. If the 
price of a commodity rises, we take it as an indication that its 
value has risen, i.e. that we can get in exchange for it more of 
other commodities than we could before ; if its price falls, we 
expect to get less of other commodities in exchange for it. 
Sometimes, however, we find that the price of a thing has 
gone up, and yet the thing will exchange for no more of 
other commodities than it would before, because the prices of 
most other commodities have gone up at the same time ; the 
price of a bicycle, for example, may have gone up to $45, and 
the bicycle still exchange for thirty bushels of wheat only, be- 
cause the price of wheat has gone up to $1.50 a bushel. When 
a change in prices occurs with apparently no corresponding 
change in values, we are forced to the conclusion that the 
change is not in the things exchanged for money, but in the 
money for which the things are exchanged. In other words, 
changes in the general level of prices mean that money, like 
other things, has its value, and that its value is subject to 

19s 



196 Economics for the General Reader 

change like other values. We say a certain suit is worth 
$20.67 ; it would be just as true to say that one ounce of gold 
(the bullion equivalent of $20.67 ^ coin) is worth that suit of 
clothes. If ten years later we find a similar suit worth $31, 
and that most other things that formerly were worth $20.67 
are now worth about $31, we shall be forced to the conclusion 
not that the value of suits has changed (except in relation to 
money), but that the value of money has changed; it has 
fallen, since half as much money again has to be given to get 
a suit, and most other things, as was needed ten years ago. 
More usually, instead of saying that the value of money has 
changed, we say that its purchasing power has changed ; the 
meaning is the same, since the purchasing power of money 
is its power to exchange for other things. 

Index Numbers. — Changes in the value of most things are 
measured by reference to money and expressed in prices; 
obviously changes in the value of money cannot be measured 
by reference to money. They can, however, be measured 
with as much accuracy, at any rate, as changes in the valae 
of other things are measured by money. No other single 
commodity will serve as a standard of money's fluctuations, 
since no single commodity is free from fluctuations in value 
greater than the fluctuations of money; if any commodity 
were capable of indicating fluctuations in the value of money, 
it would have displaced gold as the basis of currency. If, 
however, we can get the average fluctuations in price of a 
considerable number of commodities, this will give us the 
changes in the value or purchasing power of money ; this 
is done by making what is called an Index Number. A 
number of commodities are taken, and the average price of 
a given quantity of each in a given year noted; the prices 
are then totaled up and form the standard with which 
variations will be compared. The variation in prices in any 
other year can then be measured by totaling the average 
prices for this other year of the same quantities of the same 



The Level of Prices and Foreign Exchanges 197 

commodities, and expressing this total as a percentage of 
the total for the standard year. Index numbers are regularly 
published by the Loftdon Economist, the British Board of 
Trade, and by Br ads tr eel's and the Bureau of Labor in the 
United States. Various methods are employed in compiling 
index numbers, questions of " weighting," averages to be 
employed, etc., entering into the calculation. Weighting in- 
volves giving to different commodities different degrees of 
importance. Averages may be arithmetic, geometric, or 
harmonic. The simple unweighted, arithmetic average 
gives results that do not differ significantly from those obtained 
by more exact processes. All the published index numbers 
agree as to the general trend of prices. The prices on which 
most index numbers are based are wholesale, not retail prices, 
although retail prices are the prices that concern the general 
public immediately. It is more difficult, however, to get 
retail prices than to get wholesale prices, and the quality of 
finished commodities in shops varies more than the quality 
of raw materials ; the statistician, therefore, is forced to take 
the prices of raw materials and foodstuffs, and it is not 
unreasonable to assume that the relation of retail to wholesale 
prices will. not be materially different at the different periods 
imder comparison. 

Effects of Changes in Price Level. — The effects of the 
changes in the purchasing power of money, which the device 
of index numbers enables us to measure, are important. 
Contracts are frequent which cover a period of years ; a 
change in the general level of prices during the period alters 
the conditions of the contract. A farmer, for example, may 
take a farm on a seven years' lease at a rate based on current 
wheat prices ; a general fall in prices takes place, and the 
farmer finds himself still bound to pay a rent based on high 
prices, while the prices he is receiving for his produce are 
low. A general rise in prices is adverse to the interests of 
all people with fixed incomes, since their money incomes will 



igS Economics for the General Reader 

purchase for them less commodities. It is usually adverse 
to the interest of wage-earners. They are, as a class, less 
skilled at bargaining,' and have less knowledge of market 
conditions, than the employers to whom they sell their labor ; 
they do not therefore secure an increase in wages proportionate 
to the increased cost of Uving. On the other hand, a period 
of falling prices usually means an increase in the real wages of 
the wage-earners ; this is so because, as a class, they resist 
reductions of their money-wages when prices are falling more 
stubbornly and with more success than they demand increases 
in times of rising prices. Business men as a class and 
capitalists benefit by rising prices. Production is a lengthy 
process ; there is a possibility at each stage in it of buying 
materials and labor at one level of prices and selling the 
products at a new and higher level. They get what the classes 
with fixed incomes and the wage-earners lose ; the " labor 
unrest " of the last few years of rising prices has been accom- 
panied by a rapid and, in the aggregate, enormous increase 
in the amount of income assessed for Income Tax. 

II 

Causes of Changes in the Level of Prices 

Influence of Gold. — What are the causes of these changes 
in the value or purchasing power of money ? If gold were the 
only kind of money in use, the cause would be clear, viz. a 
change in the quantity of gold relative to other things. Gold 
is a commodity like other things, and its value will be affected 
by a change in its supply, just as the values of other things 
are affected by changes in their supply. If the supply of 
gold increases faster than the supply of other things, then more 
gold will have to be given in exchange for those other things ; 
if at one time a suit could be obtained in exchange for one 
ounce of gold, or $20.67, after a great increase in theproduction 



The Level of Prices and Foreign Exchanges 199 

of gold, accompanied by no corresponding increase in the 
facilities for producing suits, a man will have to give more 
than one ounce of gold for a suit, perhaps an ounce and a half, 
or $3 1 . To-day, however, gold forms only a small proportion 
of the money in use ; can we still find a connection between the 
quantity of gold and the value of money? The answer would 
seem to be that the influence of the production of gold on the 
level of prices is greater than ever it was, but is indirect. 

Difference between Gold and Other Commodities. — 
Formerly, when the precious metals were the only important 
medium of exchange, the influence on the level of prices of an 
increase in the quantity of the precious metals was direct. 
The owners of the new gold or silver offered it in exchange for 
the commodities they wished to purchase, and, in order to 
secure them, offered more of it than others were doing ; thus 
they set a new and higher gold or silver price for the commod- 
ities they purchased. It may be objected that if the new 
wealth they had acquired had been not gold or silver, but 
something else, the effect would have been the same ; they 
would have been enabled by their new wealth to outbid 
competitors for the commodities they wanted, and so force 
the prices of these commodities up. That is true, but if 
their new wealth had been anything but gold or silver, had 
been, for example, some merchandise, then the rise in price 
of the commodities they purchased would have been counter- 
balanced by the fall in price, due to the increase in the supply 
of it, of the kind of merchandise that they brought into the 
market. It is only when the new wealth which enables its 
holders to force up the prices of the commodities they want 
is money of some sort that the rise in price they cause is 
counterbalanced by no fall in price elsewhere ; it is counter- 
balanced by no fall in price, because it is itself a fall in the 
value of money. 

Indirect Influence of Changes in Gold Supply. — To-day 
the direct influence still operates, since the holders of the new 



200 Economics for the General Reader 

gold will use it for purchases ; it is, however, comparatively 
unimportant, first, because the proportion of gold payments to 
other payments is small, and secondly, because new gold 
nearly always as a matter of fact finds its way to some bank ; 
the owners of the new gold prefer the convenient right to draw 
checks on a bank to the inconvenient necessity of handling and 
safeguarding large quantities of bullion. Now banks, as we 
saw, create currency or money by giving to their clients 
credits subject to checks in return for security. The extent 
to which they will make such advances with a given cash 
reserve varies with the state of feeling in business ; but, 
other things being equal, as their cash reserve increases they 
can and will increase their advances, that is to say, the amount 
of currency or money that they create. Thus an addition to 
the supply of gold will indirectly, by increasing the cash 
reserves of the banking system, increase the amount of money 
in circulation by much more than the amount of gold brought 
in. The new money, whether it be an advance which a bank 
has granted on the basis of its increased cash reserve, or a 
current account which one of the owners of the new gold has 
acquired by depositing his gold with a bank, will enable its 
holders to offer more for the commodities which they want 
than they would otherwise have been willing and able to 
give ; the prices of these commodities will rise, and the rise in 
price beginning with them will be transmitted to other 
commodities, since the sellers of them will be enabled by the 
higher prices they receive to offer higher prices for other 
commodities which they want. Thus an increase in gold- 
production can still affect prices, although the proportion of 
payments actually made in gold is small; it affects prices 
chiefly through bank reserves, increasing them, and thereby 
enabling the banks to increase their advances. Until a 
generation ago, the growth of the world's gold supply was slow 
and barely kept pace, if it did keep pace, with the increase of 
wealth in other forms, for each year's addition was insignificant 



The Level of Prices and Foreign Exchanges 201 

compared with the existing accumulations of the past. During 
the last generation the discovery of new goldfields, together 
with the discovery of the cyanide process of extracting gold 
from the ore, has altered this ; since 1899 the annual increase 
in the world's supply of gold has been so great that we may 
expect the world's total supply to be doubled in the course 
of two generations. It is unnecessary therefore to look further 
for the chief explanation of the recent rise in prices. 

Relative Importance of Changes in Gold Production. — 
There are, however, other influences. An increase in gold- 
production will raise prices only when it is greater than the 
increase in other forms of wealth ; it is the relation between the 
two that influences the level of prices. Hence a great in- 
crease in gold-production may be counterbalanced by a more 
rapid increase in other forms of wealth, due to the progress 
of technical invention or the opening up of new countries 
with great and untouched natural resources, so that prices 
will even tend to fall. Or an increase in gold-production, 
in itself not very great, may be accompanied by a falling off 
in the production of other important forms of wealth, and 
prices will rise faster than they have done when the rate of 
gold-production has been greater. Such a falling off may be 
a contributory influence in the recent rise in prices ; the world, 
and especially the United States, is filHng up, the first fertility 
of virgin soils has been exhausted, and the secular struggle 
between invention and the tendency of nature to give de- 
creasing returns to our expenditure on her may for the moment 
have gone against invention. 

Volume of Exchanges. — There is another difficulty to be 
faced before we can understand the relation between the 
supply of money and the level of prices. Money is wanted, 
not for the sake of its intrinsic physical properties as are most 
commodities, but for the sake of its purchasing power, as a 
means of obtaining other things. If we use the word 
" money " strictly, and not as it is commonly used as a mere 



202 Economics for the General Reader 

synon3rtn for " wealth," we see that the want it satisfies is 
the want for a medium of exchange which every society prac- 
ticing specialization experiences. The relation therefore on 
which the level of prices depends is not exactly the relation 
between the amount of money and the amount of other kinds 
of wealth, but the relation between the amount of money and 
the " amount of exchange " (if the phrase may be permitted) 
which that money has to effect ; and the amount of exchange 
depends partly, it is true, on the amount of other forms of 
wealth, increasing as a rule as that increases and decreasing 
as it decreases, but partly also on the frequency with which 
these other forms of wealth are exchanged. If the amount 
of money is stationary, then an increased amount of exchange 
can be effected only at lower prices ; while an increase in the 
amount of money, occurring when there is no increase in the 
amount of exchange, will send prices up, since there will be 
more money to change hands every time a thing is bought 
or sold; The frequency of exchange depends chiefly on the 
extent to which speciaHzation has been carried, and, since 
specialization is constantly being carried further, the fre- 
quency of exchange tends to grow and to exert a depressing 
influence on prices. Where, however, speciaHzation takes 
place within the firm, it does not increase the frequency of 
exchange, and when a number of firms that formerly bought 
from and sold to one another are combined into a single firm, 
the frequency of exchange will be reduced without any reduc- 
tion in the extent of specialization. 

Rapidity of Circulation. — Just as an increase in the fre- 
quency of exchanges increases the need for money and will 
force prices down if an increased supply of money is not forth- 
coming, so anything that increases the rapidity with which 
money circulates and does its work will have the same effect 
as an increase in the actual amount of money, and tend to 
send prices up. Thus improvements in the means of com- 
munication may, as one of their effects, tend to send prices 



The Level of Prices and Foreign Exchanges 203 

up. An increase in the skill of bankers or in the stability of 
business, by enabling bankers to give more credit on the basis 
of a given cash reserve, will result in an actual increase in 
the amount of currency, tending to raise prices. 

Relation of Money-value to Price-level. — The level of 
prices is the value of money. A rise in prices does not cause 
— it is a fall of the value of money, since it means that a 
given quantity of money will exchange for a smaller quantity 
than before of other things. A fall in prices is a rise in the 
value of money, since it means that a given quantity of money 
will exchange for a larger quantity than before of other things. 
The value of money depends, Hke the value of everything else, 
on the relation between the supply of it and the demand for 
it. The supply of money is made up almost entirely of gold 
and bills, checks, and notes, which are all of them under- 
takings to pay gold ; any increase in the supply of gold, by 
enabling an increase in the issue of these undertakings to 
pay gold, will effect a more than proportionate increase in 
the supply of money. The demand for money is the amount 
of exchange that has to be effected by it ; this depends chiefly 
on the amount of other forms of wealth, but partly also on 
the frequency with which they exchange. Temporary changes 
in the demand for money can be met by banks increasing or 
diminishing their credits ; ultimately, however, these credits 
depend on and are limited by the gold reserve of the banks. 
In the long run, therefore, the chief influence on the level of 
prices, which is the same thing as the value of money, is the 
relation between the rate at which the supply of gold in- 
creases and the rate at which the supply of other kinds of 
wealth increases. 



204 Economics for the General Reader 

III 

The Law of Comparative Cost 

International Trade. — It remains to consider international 
exchange, a subject we could not take up until we had seen 
how changes in the amount of gold affect the level of prices. 
Exchange takes place between countries for the same reason 
that it takes place between districts in the same country, be- 
cause countries are specialized and can obtain some things 
they need more easily by offering their own special products in 
exchange for them than by producing them in their own area. 
Exchange between countries is as a rule more difficult than 
between different districts in the same country. The differ- 
ences in language, in currency, in law and trading custom, 
the greater distances and the greater risk involved as a rule in 
foreign trade, are all obstacles to the free movement of 
goods ; to these must be added the obstacles deliberately 
imposed by governments in the shape of import duties. In 
spite of them all, however, the action of the middleman, buy- 
ing in the cheapest and selling in the dearest market, links 
countries together ever more closely, and international 
specialization, with its correlative international exchange, 
increases. 

Conditions Giving Rise to Trade. — Climate, the character 
of the soil and mineral deposits, the density of population, 
the degree of industrial development, fit different countries for 
different branches of production; by the different countries 
giving most of their productive powers to the work for which 
they are most fitted, all benefit. Each utilizes to a greater 
degree than would otherwise be possible its natural and social 
advantages, and obtains in exchange for its own products 
the products of other countries cheaper than it could produce 
them itself in the same quantity. Countries, however, often 
import from other countries commodities which the importing- 



The Level of Prices and Foreign Exchanges 20$ 

country could produce actually cheaper than the exporting 
country. Thus England imports dairy produce from Ireland 
and Denmark, although English pastures are no less fertile than 
the pastures of those countries, and wheat from India where 
methods of agriculture are immeasurably less advanced. 
Farming usually declines in a district when coal is discovered 
under the land and coalworking begun, although the fertility 
of the soil is not affected by the new mining operations. 
The Channel Islands import wheat, using their land to 
raise more valuable vegetable and dairy products, and wine 
districts import commoner fruits which they could raise 
themselves at much less cost than the districts from which 
they import them. The fact that a commodity can be 
produced at a lower cost by one country than by another is 
no guarantee that it will pay the first country to produce it 
and not import it from the second ; there may be other 
commodities in the production of which the first country has 
an even greater advantage, in which case it will specialize in 
them. 

Comparative Cost. — Thus it is the comparative cost of 
producing different commodities in different countries that 
determines which country shall specialize in which commodity. 
A country may be able to produce each of a number of com- 
modities cheaper than they can be produced in a second coun- 
try with which it trades ; it will not therefore produce them 
all for itself (otherwise trade would cease between the two 
countries) ; it will concentrate on those commodities in the 
production of which it has the greatest advantage over the 
other country, while the other country will specialize in those 
commodities in the production of which it is at the least dis- 
advantage. 

Joint Advantage. — Both countries benefit by this arrange- 
ment. Each country, by specializing in those commodities 
for the production of which it has the greatest relative advan- 
tages, obtains a bigger return for its expenditure of labor and 



2o6 Economics for the General Reader 

capital than it would have done if it had not specialized but 
had devoted part of its efforts to producing the commodities 
for which it was relatively less well fitted. The total product 
of the two countries together will be greater than if each had 
produced all the commodities without specializing. Each 
country will be able to offer the other in exchange for the 
other's special products a greater quantity of its own special 
products than the other could have produced for itself with 
the labor and capital it expended in producing the products it 
exported in exchange. If England can produce both fine cot- 
tons and coarse cottons better than Germany, but has a greater 
advantage over Germany in producing fine cottons than in 
producing coarse cottons, then the tendency will be for Eng- 
land to specialize in the finer cottons and Germany to specialize 
in the coarser cottons, and for the two to exchange their 
special products; England will be able to offer Germany 
more fine cottons in exchange for a given quantity of coarse 
cottons than Germany could have produced for herself with 
the same expenditure of labor and capital as was required 
to produce the coarse cottons which she exported, and England 
will obtain a greater quantity of coarse cottons than she could 
have produced with the labor and capital which she expended 
in the fine cottons which she exported. The cost of our imports 
is our exports; so long as we can produce our exports with a 
less expenditure of labor and capital than would be required 
to produce at home the imports we get in exchange for our 
exports, we gain something, even if we could produce the 
things we import at a lower cost than the countries that send 
them to us. An industrial country like England could raise 
more of her food, but finds it cheaper to buy it with her manu- 
factures from countries like Denmark and India that have not 
the coal required for manufactures ; England could make the 
coarse cottons she imports, but to do so would be to waste 
the relatively greater advantage which her more developed 
organization and the higher skill of her artisans gives her in 



The Level of Prices and Foreign Exchanges 207 

making the finer and more valuable cottons. If her coal- 
fields became exhausted, or the discovery of some new and 
more efficient source of power deprived her of the relative 
advantages in manufacture which they now give her, then she 
might find that her facilities for agriculture were, relatively to 
other countries, greater than her facilities for manufactures, 
and she might become again primarily an agricultural country, 
as she was before the eighteenth century. 

IV 

Imports Paid Jar by Exports 

Complicated Nature of Modern Trade. — The cost of our 
imports is our exports. Our exports pay for our imports. 
This is not obvious, because the totals of the recorded imports 
and exports of any country rarely balance. The recorded 
imports and exports, however, never account for all the ex- 
change of goods and services between one country and the 
rest of the world. Records are kept only of material commod- 
ities, while a country usually supplies and receives from other 
countries services as well as commodities. To understand 
how a country's exports pay for its imports, therefore, it is 
necessary to take into account everything of market value that 
the country supplies to the rest of the world, and everything 
that it receives from the rest of the world. England, for 
example, in normal times supplies other countries not only 
with its exports, but with a large part of the services of its 
mercantile marine, and of its banking system and insurance 
companies ; since it receives much less than it gives in the 
case of shipping, banking, and insurance, it will have to 
receive more goods (or recorded imports) than it exports, to 
make up the difference. Further, citizens of the United 
Kingdom have a large amount of capital invested abroad ; 
some foreign capital is invested in England, but not nearly 



2o8 Economics for the General Reader 

so much. Interest is due on this capital every year, so that 
the United Kingdom has another claim on other countries 
which will be liquidated in goods or recorded imports. The 
export of capital swells the total of recorded exports, the 
corresponding " import " being the scrip which constitutes 
the English investor's title to the foreign stock ; foreign invest- 
ments in the United Kingdom swell the recorded imports of 
the United Kingdom, since the foreign capital will come in the 
form of goods, British stocks and shares being exported in 
return; similarly, repayment of British loans abroad will 
swell the British recorded imports. 

Invisible Items. — A comparison of the recorded imports 
and exports of a country therefore will tell us little ; to under- 
stand its economic relations with other countries we must 
take into account all the transactions that give it a claim on 
other countries and all the transactions that give other 
countries a claim on it : not only imports and exports of 
goods, which are recorded by Customs officers, but " invisible " 
imports and exports — stocks and shares, services of shipping, 
financial and insurance houses, hotel-keepers, etc., and claims 
to interest on foreign investments. So far as these two sets 
of claims balance they will cancel out, so far as they do 
not the balance will be settled by the transfer of gold ; but, 
for reasons which we have now to examine, they always tend 
to balance, and the movement of gold, when they do not 
balance, automatically sets at work forces that tend to restore 
the balance. 

The Part of Gold. — Imports and exports — in the wide 
sense of these terms that we have just described — will 
always tend to balance, for the same reason that the purchases 
which an individual can make are usually equal in amount to 
the sales which he can effect. The individual's purchases are 
limited by his income, which depends on the value of the 
Services or commodities he sells to other people ; similarly, the 
purchases that a country can make are Hmited by the value 



The Level oj Prices and Foreign Exchanges 209 

of the goods and services that it can sell to other countries, 
unless it is to become bankrupt. But over a short period 
imports may exceed exports, or vice versa, and the balance 
will have to be settled by a transfer of gold. 



The Balance of Trade and the Level of Prices 

Methods of Financing Foreign Trade. — From the point of 
view of the individual trader foreign trade is buying and 
selling, like home trade : in principle it does not differ at all. 
Since, however, payments have to be made in another coun- 
try, and perhaps in a different currency, they are usually 
made not by check but, as we have seen, by bill of exchange. 
An importer can pay for his import by accepting a bill drawn 
on him by his foreign creditor ; more usually he will arrange 
with a bank or financial house to accept for him bills drawn on 
them by his creditor. Or he can buy for cash in his own coun- 
try a bill drawn on some one in the country of his creditor 
and payable there ; this he will send to his creditor in pay- 
ment for his import. Or he can send bullion, which is much 
more expensive than sending a bill. Since before the war a 
bill drawn on London was almost the only kind of bill which 
the holder could be sure of converting into gold in case of 
any failure of credit, bills drawn on London were preferred 
to bills drawn on any other commercial center; foreigners 
who sent goods to England preferred drawing on London and 
selling the bill to some one desiring to pay for goods obtained 
from England, to being paid \vith bills, drawn on fellow- 
countrymen and payable in their own country, which had 
been accepted by fellow-countrymen who had bought goods 
from England. Since the war bills drawn in dollars on New 
York have come into considerable vogue. But however the 
bill is created, once it is created it becomes itself a sort of 
p 



210 Economics for the General Reader 

merchandise, dealt in by middlemen, and fluctuating in value. 
This is so because the drawers of bills usually do not want to 
hold the bills till they fall due; they want cash, and there- 
fore discount them, and the banks or brokers into whose 
hands they thus come offer them for sale to importers who 
have debts to pay in the country where they are payable. 

Rates of Exchange. — Now let us suppose that England 
has been buying from the United States more than the United 
States has been buying from England. Then there will be 
Englishmen, with debts to pay in America of greater amount 
than the debts which Americans have to pay in England. 
The claims that Englishmen have on Americans will not 
balance the claims that Americans have on Englishmen, and 
gold will have to be exported to the United States to pay the 
difference. Now it is expensive to send gold and insure it 
during transit; hence bills which obviate the necessity will 
be at a premium. Bills will be at a premium in London, 
because more are wanted than are available, while bills will 
be at a discount in New York, because there are more available 
than are needed to pay American debts in England. It may, 
however, happen that while England has bought more from 
the United States than she has sold to the United States, she 
may have sold more to Germany than she has bought from 
Germany, and Germany have sold more to the United States 
than Germany has bought from the United States. In that 
case the English traders will be able to purchase bills in 
Berhn which will be acceptable in the United States, where 
they will be used to meet German claims in the United 
States. Thus the indebtedness of England to the United 
States and Germany together and the claims of England on 
the United States and Germany together will just balance, and 
the transfer of gold be averted. But the existence of " three- 
cornered " exchanges like this does not alter the principle ; at 
any given time a country may have more debts to pay than it 
has claims to present to other countries, the exchanges will 



The Level of Prices and Foreign Exchanges 211 

be " against " it, gold will have to be transmitted, and bills 
which have only a short term to run and obviate the necessity 
to transmit gold will rise above their face value. 

" Gold-Points." — There are limits to the fluctuation in 
the value of bills. If the demand for a foreign bill so exceeds 
the supply that the premium on it rises above a certain point, 
it is cheaper to pay the expense of sending bullion ; this sets 
an upper limit to the bill's fluctuation. If the supply so 
exceeds the demand that the value of the bill falls below a 
certain point, it pays either to hold it until it falls due or to 
send it to the place on which it is drawn, get it discounted, 
and pay the expenses of bringing the gold back. For example, 
the bullion equivalent of an English sovereign in United States 
money is $4.8665 (called " the mint par ") ; it costs about 
$.03 in normal times to transfer (and insure during transit) a 
sovereign between London and New York ; hence the limits 
to the fluctuation in value of London bills in New York or 
New York bills in London are $4.8365 (4.8665 — .03 dollars) 
and $4.8965 (4.8665 + .03 dollars) ; these are called the 
" gold-points," because they are the points at which it pays 
to transmit gold instead of bills. In the case of exchange with 
countries having a silver or inconvertible paper currency, we 
have corresponding " specie-points," at which it pays to 
transmit specie ; but we cannot in this case state what these 
points will be, since there is no mint par of exchange, and the 
value of bills varies with the value of silver (or the inconvertible 
paper money) measured in gold, as well as with the changes in 
the supply of them and demand for them. It should be 
stated that there are certain exceptional cases, of no great 
importance, where the value of bills fluctuates beyond the 
limits set by the gold-points. 

Effect of Gold Movements. — Suppose the United States 
has been buying more than she has been selling, so that the 
exchange is against her and it becomes cheaper to transmit gold 
than it is to send bills, what is the effect of paying these 



212 Economics for the General Reader 

foreign claims by sending gold out of the country ? We have 
seen that the level of prices generally is intimately connected 
with the supply of gold ; over a short period the same intimate 
connection exists between the supply of gold in any one country 
and the level of prices, since there are, as we have seen, 
obstacles to that free movement of wealth from country to 
country which would be needed to maintain prices at a 
uniform level in all countries. Therefore when the foreign 
exchanges move against the United States and it becomes 
necessary to send gold out of the country, the level of prices 
in the United States will be affected. Banks, having their 
reserves depleted, will restrict their advances, thus lessening 
the purchasing power of the business community, and prices 
will fall. While prices are falling in the United States, the 
gold the United States is exporting will be having just the 
opposite effect in the countries to which it has been sent, that 
is to say, it will be raising the level of prices there. Now, 
the fall in prices in the United States will make it profitable 
to foreigners to buy in the United States goods which pre- 
viously they could get cheaper elsewhere, and will thus 
stimulate exports ; especially will foreigners take advantage 
of the low prices to buy American Stock Exchange securities. 
At the same time the rise in prices in the countries to which the 
gold goes will check American purchases there. Hence the 
tendency of the United States to buy more than she sold, 
which gave rise to the unfavorable movement of the exchanges 
and the export of gold, will be reversed; the United States 
will tend to buy less and sell more, and the balance between 
the claims for and against her will be restored. As a result 
of this change in the balance of trade, bills will become more 
plentiful at home and will fall within the upper gold-point; 
they will become less plentiful abroad and will rise above the 
lower gold-point, so that the necessity for transmitting bullion 
disappears. 
Thus, international payments are settled by canceling 



The Level oj Prices and Foreign Exchanges 213 

contrary claims through the medium of the bill of exchange. 
Gold is used only to settle balances when the claims which a 
country has on other countries do not quite equal the claims 
which other countries have on it ; and the movement of the 
gold starts a change in levels of prices which leads to a res- 
toration of the balance between a country's purchases and its 
sales. 



CHAPTER XII 

THE CIRCULATION OF WEALTH 

I 

Wealth and Production 

Involved Character of Wealth. — We have not yet asked 
ourselves the question, "What is Wealth?" It did not 
arise in our study of the economic structure of society ; but 
it must be faced before we go on to the study of distribution. 
In the deepest sense in which the word "Wealth" can be used 
Economics does not attempt to answer the question ; because 
in the deepest sense of the word the question " What is 
Wealth? " is a moral question. Our view of true wealth 
depends on our moral and religious views. Christian and 
Mohammedan, artist and manufacturer, scholar and drunkard, 
have different views as to what is true wealth. But in the 
ordinary use of the word they all agree ; in ordinary speech we 
ignore this deeper meaning of the word " Wealth," and Eco- 
nomics follows ordinary speech in this respect. 

Income and Wealth. — In ordinary speech a wealthy man 
is a man with a large income. How do we state a man's 
income? Usually in dollars and cents, and in the same way 
we state a country's income in terms of money. So we say 
that the United States is a wealthy country, having an income 
of some forty or fifty billion dollars a year. But the dollars 
and cents are not the wealth. No one, except the miser, 
desires them for their own sake; they are wanted only for 

214 



The Circulation of Wealth 215 

their purchasing power — we state wealth in terms of money 
merely because money is the only standard of wealth we 
have. The real wealth consists of the things that the money 
will purchase, and of those things we think when we try to 
realize what wealth is ; the precious metals and precious stones, 
the materials and implements of manufacture, foodstuffs, 
land, and buildings, these and not their money prices are 
what we mean by wealth. But there are other, less tangible 
things we buy with money — the surgeon's skill, the musician's 
art, the services of preacher and teacher, and a thousand 
others ; what have these in common with the tangible, obvious 
forms of wealth we thought of before? They have only one 
quality in common, they satisfy human want and desire, and 
it is that quality that makes us regard them all as " wealth." 
Characteristics of Wealth. — The power to satisfy human 
want, or aid the satisfaction of human want — that is what 
the economist, following the usage of ordinary speech, requires 
of a thing to make it wealth. *' Anything that satisfies, 
directly or indirectly, a human want, and is not unlimited in 
quantity," is the definition of wealth that Economics, follow- 
ing ordinary usage, has formulated. No matter what the 
want is, whether it is bad or good, men regard as wealth the 
means for satisfying it ; opium and quinine, Shakespeare's 
plays and the latest sensational novel, gold and iron, are all 
alike forms of wealth because they satisfy wants; the pro- 
duction of them swells the national income and enriches their 
owner. The means of satisfying the want must not be un- 
limited in quantity, or it will not be regarded as wealth ; a 
thing must not only satisfy want, but must require some effort 
or sacrifice to acquire it, before it comes to be regarded as 
wealth in the ordinary sense of that word. Air and sunlight 
therefore, although far more important to life than steam- 
engines and gas supplies, do not count as wealth in the esti- 
mation of any individual's or any conmiunity's wealth, while 
the latter do. 



2i6 Economics for the General Reader 

Nature of Wealth Production. — If wealth then is the satis- 
faction of human want, any one or anything that satisfies a 
human want or helps to satisfy it, is producing wealth. There 
are individuals in society who receive incomes without pro- 
ducing anything; they are sometimes called parasites. 
Property-owners, for instance, receive income without pro- 
ducing anything ; but their property helps to satisfy human 
wants in the many ways we have seen. If it is land, it is the 
source of raw materials ; if it is capital, it is producing in the 
form of machines, or keeping workers while they are engaged 
in the roundabout methods of modern production. And in 
all Western countries the rule is, that anything that is pro- 
duced by a thing is the property of that thing's owner. The 
rule may be a bad one — we shall criticize it in Chapter 
XXII — but it differentiates property-owners from the 
parasite proper, who lives upon gifts, taking no part directly 
or indirectly in the productive process. It is sometimes 
thought again that such people as managers in factories and 
middlemen in commerce are not producers, because they do 
not alter in any way by their labor the shape of the materials 
of manufacture. As we have seen, however, these classes are 
necessary to organize the work of specialized workers, if so- 
ciety wishes to utilize the advantages of specialization, and 
in that way they help production ; production would not be 
so large or so varied but for their work. 

Immaterial Wealth Production. — The professions must 
also be regarded as productive. It is true that they produce 
nothing material or tangible, but they satisfy human wants. 
If the farmer is a producer because he produces food, the 
doctor must be considered one if he helps us to digest the food. 
If the workman is a producer because his skill shapes material 
objects to our needs, the technical teacher who has helped 
the workman to get that skill must be considered a producer ; 
and the technical teacher's work is based on the discoveries of 
pure science, which must therefore be regarded as productive. 



The Circulation of Wealth 217 

And the same is the case with the servants of governments. 
The ordinary work of production could not go on unless law 
and order were maintained. Men and women carmot live 
together in societies without rules to prevent them from getting 
in one another's way, and a whole machinery of government is 
needed to enact these rules and to see that they are carried 
out. Indirectly, therefore, civil servants and the judicial 
services are helping to satisfy human wants, i.e. are produc- 
ing wealth. If, then, men's wants and desires were for ma- 
terial things only they could not be satisfied without the 
labours of all sorts of professional men, whose work therefore 
is productive. But "man doth not live by bread alone"; 
human nature seeks satisfactions which are not given by ma- 
terial objects. It has other wants besides material ones, and 
any person who satisfies these wants is producing wealth in 
exactly the same sense as the workers who produce any ma- 
terial object. The preacher and the teacher, the artist and 
the journalist are all of them engaged in satisfying human 
wants, are all of them producers. 

The view that only the production of material objects is 
true production would tell against the views of its holder if 
pushed to its logical conclusion. In that sense no man ever 
produces anything. The fundamental laws of physics are 
the conservation of energy and the indestructibihty of matter, 
and what man does is to change the form of matter given by 
Nature, to change the kind and direction of energy given by 
Nature ; he alters, shapes, and directs forces, not creating 
anything. At the end of all his work there is the same weight 
of matter and the same volume of force in the universe as 
there was at the beginning. What all labor is directed to is 
the satisfaction of human wants, and that satisfaction is 
wealth, whether it is given directly in the form of services 
or indirectly by giving to some material object the shape and 
form which will enable it to satisfy human wants. 



2i8 Economics for the General Reader 

II 

Income and Capital 

Immaterial Elements in Wealth. — We have spoken through- 
out of " income " ; this is not in accord with the usual notion 
of wealth. The usual notion is that wealth consists of a 
stock or fund of objects, and that the wealth of a community 
could be stated in the form of an inventory of all the goods in 
the community. This view is partly due to the belief that 
only material objects form wealth, though, as we have seen, 
material objects themselves are only wealth because they 
have the capacity to satisfy human wants. Such an inventory 
would include much of the wealth of a community at any 
moment — its lands, its machines, its raw material and 
finished goods, its buildings and their furnishings, and so on ; 
but it would exclude some important forms of wealth, some 
important possessions which enable us to satisfy wants. It 
would exclude the skill of the workman and the knowledge of 
the scientist and the organization of industry, all, that is to 
say, that enables us to keep up our stock of material objects, 
to replace what decays or wears out ; and it would ignore all 
that the professions can do to satisfy human wants, since it 
would include only the surgeon's instruments, while ignoring 
the skill that enables him to use them. 

Income as Measure of Wealth. — Such a method would be 
a very imperfect method of dealing even with material objects. 
What, for instance, would be the use of including in an in- 
ventory a machine without giving us any indication of what 
the machine could do ? It might give the original cost of the 
machine, but that is no indication of the capacity of the 
machine to satisfy wants, since the machine may be worn out 
or have become obsolete. It is only by the product of the 
machine, by the income which it will give, that we can tell its 
value, and if we wish to state the value of the machine in a 



The Circulation oj Wealth 219 

lump sum we can do so only by capitalizing the income 
derivable from it, i.e. by calculating what sum of money would 
be needed at the current rate of interest to give an income 
of the value of the machine's product. If we wish to represent 
wealth as a fund or stock, we could get it only by capitalizing 
incomes generally. The present value of a house is not what 
it cost to build, but so many years' purchase of the rent it will 
yield. The value of a doctor's skill is his income, multiplied 
by the number of years that he will be able to exercise his 
skill. If we wish, then, to measure the wealth of a society we 
can do it only by calculating its income, not by totaling up 
the value of the goods it may possess at any moment. 

The notion that wealth is a stock or fund, and income the 
fruit of this stock, is a conclusion very easily drawn from cer- 
tain aspects of production. Land gives an income in the 
form of crops, and the land remains when the crop has been 
taken. A flock gives an income in the form of the year's clip 
and the year's lambs, and the flock is there at the end of the 
year. A machine produces so much every year, and at the 
end of the year the machine remains apparently much as it 
was at the beginning. We invest our savings in some com- 
pany, and each year we draw a dividend on our capital which 
leaves the capital unimpaired and ready to yield a dividend 
next year. This view does not go below the surface. The 
dividend is not always paid. It is not paid when the expenses 
of the business exceed the receipts. When it is paid, it does 
not represent the whole of the product of the business for the 
year, because, before the business could pay any dividend 
at all, it has had to pay out of its product all the expenses for 
labor, management, and materials. It has had to replace from 
the same product all the wear and tear of plant and buildings. 
Only a very small part of the entire product of the business 
reaches the owners of the business in the form of dividends ; 
the greater part has been needed to keep the business alive, 
because businesses wear out. A machine does exist at the 



220 Economics for the General Reader 

end of the year apparently in the same condition as it was at 
the beginning of the year, but the sameness is only apparent. 
All through the year the machine has been wearing out. It 
has been growing obsolete, and out of the product of the 
machine the cost of this wear and tear has to be taken, and a 
sinking fund supplied to provide a new machine when the 
present one is obsolete. The machine is being " consumed," 
only we do not notice it because the consumption is so gradual. 
Even land, agricultural land, has not the permanence that we 
commonly attribute to it, because it loses its fertility and this 
fertility has to be restored to it. It continues to yield a crop 
only because some of the value of each year's crop has been put 
back into it in the form of manure and work ; and if this is the 
case with the land itself, much more obvious is it that the farm 
buildings, dikes, fences, etc., all wear out and have to be 
replaced before there is any net income received from the 
land. 

Necessity for Replacement. — In a word, everything that 
we produce is consumed ; if the consumption is objectless we 
call it waste, but by deliberate use or waste everything is 
consumed. Usually the instruments of production wear out 
slowly, they are used many times. But it is not their greater 
durability that constitutes them capital, it is their use ; 
capital is not certain forms of wealth, but any form of wealth 
put to a certain use, namely that of assisting the production of 
further wealth. The manufacturer's loom is capital, because 
it is aiding labor in the production of cloth ; but the cloth 
on the tailor's shelves is equally capital, since it enables him 
to carry on his business, to give his customers what they 
want when they want it, without keeping them waiting while 
he orders it. Capital wears out or grows obsolete, and has 
to be replaced ; the capital of a company remains the same in 
apparent amount, only because this constant replacement 
from income is duly kept up. Land becomes exhausted, and 
has to be revived. Land and capital remain the same in the 



The Circulation of Wealth 221 

same way as the schoolboy's knife is the same when it has had 
two new blades and a new handle. We are told that the 
substance of the human body is renewed completely every 
seven years ; in the same way the substance of the economic 
body of society is constantly being renewed ; land, labor, 
and capital produce, and out of their product they are renewed. 

Ill 

Spending and Saving 

Need for Saving. — This constant decay and renewal is the 
explanation of the title given to this chapter, the circulation 
of wealth. If we think of society as a body and wealth as the 
blood, the agents of production are the heart, continuously 
taking in and giving out wealth. This regular renewal of 
the means of production does not go an automatically ; it 
requires continuous effort and sacrifice, and the great volume 
of wealth required for this purpose is one reason why the flow 
of wealth, which can be annually distributed as wages, profits, 
and rent, is no larger than it is — one reason for the apparent 
discrepancy between society's income and its vast productive 
power. At any moment the productive capacity of society 
is limited by the amount of its capital, the natural riches 
and state of development of its land, and the number and 
efficiency of its population. It can always increase its pro- 
ductive capacity by increasing its capital, improving its land, 
or increasing the efficiency of its population ; but if it wants 
to use its current income for any of these purposes, it cannot 
use them for the satisfaction of current wants. 

Difference between Spending and Saving. — Individuals 
and society have at every moment to decide how much of 
their income, how much of the productive capacity at their 
command, shall be devoted to aiding future production. 
That part of income that is devoted to aiding future production 



222 Economics for the General Reader 

is said to be saved. That does not mean it is not spent or 
consumed ; it means that it is spent or consumed to aid further 
production. If the income has been received in cash, the 
saved portion is put in a bank and the bank lends it to business 
men who use it to aid their work of production; or it is 
invested; that is, the owner puts it into a business which 
uses it to buy buildings, plant, materials, etc. We may 
put the case concretely by saying that " savings " constitute 
a demand for buildings, machines, materials, and stock-in- 
trade, while the rest of income is a demand for food, clothing, 
shelter, and other goods and services for immediate consump- 
tion ; both are spent, but the object of spending is different 
in the two cases. 

Expense of Capital and Labor. — If the wealth of a 
country is to be maintained, the depreciation of capital, the 
repairs and renewals of land, and number and efl&ciency of its 
workers must be kept up out of its gross income. Business 
men recognize this when they speak of the danger of " driving 
capital abroad " by oppressive taxation. The machines and 
buildings at present in use as capital cannot be exported ; but 
the income derived from these machines and buildings can 
be applied not to repairs and renewals of them, and additions 
to them at home, but to the establishnient of new factories 
abroad. Similarly, land may be neglected, and give a de- 
creasing income year after year. But the greatest danger to 
the future prosperity of a country is the neglect of its workers. 
Underfed, badly housed, ill-educated, or casually employed 
workers give inefficient labor, and these ill effects are cumu- 
lative, since the present generation is largely responsible for 
the quahty of the next. Similarly oppressive legislation, or 
the absence of legislation to prevent oppression, which to-day 
is a greater danger, will drive labor out of the coimtry. The 
growth of England's manufactures before the Industrial 
Revolution was greatly helped by the immigration of Flem- 
ings and Huguenots who were driven from their native coun- 



The Circulation oj Wealth 223 

tries, and England's gain was the other countries' loss. Social 
inequalities may have the same effect as oppressive legislation. 
There is no doubt that the European working man of enter- 
prise and energy has better prospects in the United States, 
Canada, and South America than he has at home ; hence the 
constant exodus from Europe of emigrants who, discontented 
with their prospects at home, go to contribute to the wealth 
of countries where the career open to talents is nearer 
realization. 

IV 

The National Dividend or Income 

Demand for the Factors of Production. — Because wealth 
is a " flow," a country can always pay for new goods and 
services; there is always a demand for additional labor, 
capital, and land ; there is always room for new inventions 
and improvements in organization. This assertion may seem 
strange when we are constantly hearing of capital seeking 
investment, land lying idle, and, above all, labor unemployed. 
It is perfectly true that capital, land, and labor are often 
unemployed ; but the reason for their unemployment is 
certainly not that the income of the country is fixed and 
limited, so that any labor-saving device, whether machinery or 
better organization, must permanently displace some of the 
labor and capital at present employed ; there may be a 
temporary displacement, and some workers may suffer, but 
in the long run the introduction of " labor-saving " machinery 
increases the demand for labor. 

Example. — Let us work out an example. A shoe manu- 
facturer, employing a hundred hands, introduces a machine 
which enables him to produce with seventy-five hands as 
many shoes as before ; what happens ? He may decide to 
produce more shoes and keep on his hundred hands ; if he 
makes more shoes, he will have to sell them at a lower price — 



224 Economics for the General Reader 

as presumably he can do, thanks to his new machines — or 
the market will not take them. The net effect in that case 
is that no labor is displaced, additional labor is required for 
making the machines, and some people who could not afford 
his shoes before can afford them now. But suppose he does 
dismiss twenty-five hands. The additional demand for 
labor to make the new machinery still remains, but that is not 
equivalent to the falling-off in the demand for labor in the 
shoe factory. The true equivalent is found in the increased 
demand which the manufacturer makes for labor owing to his 
increased income. His expenses of production are less, he 
has as many shoes as before to sell, therefore his income will 
be bigger. He will spend the increase or " invest " it ; if he 
spend it, it constitutes a new demand for the labor required to 
make the things he wants ; if he invests it, it constitutes a 
new demand for the labor required for the machines, buildings, 
etc., of the business in which he invests it. 

In time, however, other manufacturers will adopt the 
new machinery, their competition will compel our manu- 
facturer to reduce his prices nearer the cost of production, 
and his income will come back to its old dimensions. Corre- 
spondingly his demand for labor will fall, and we seem to 
have a net reduction in the demand for labor. But we have 
ignored the fall in the price of shoes ; that fall has released so 
much of the income of all the people who buy this class of 
shoes, and enables them to buy either more shoes or more of 
something else; thus even if their demand for the labor of 
shoe operatives has fallen, their demand for the labor of the 
operatives who make the other things that they buy has 
increased. If they decide, as is perhaps the most usual case, 
to buy more shoes, then their demand for labor of all kinds 
remains the same as it was before. Provided, therefore, that 
the twenty-five shoe operatives displaced by machinery 
can find out what will be wanted either by their employer, 
who now has a bigger income to spend, or by his customers. 



The Circulation oj Wealth 225 

who, getting their shoes cheaper, can buy something they 
could not afford before, they will not be unemployed. 

Labor-saving Machinery. — It is something like this 
crude example that usually happens when " labor-saving " 
machinery is introduced. Usually the introduction is gradual ; 
often the new machinery is used only for a cheaper class of 
goods that was not made before. The output of the industry, 
introducing the new machinery, will not remain stationary, 
and some of the hands — perhaps all — who would have been 
displaced if the output had remained stationary will be kept on 
to work the new machines. But if some are displaced, there 
will be an increase in the demand for labor in other industries 
owing to the increased purchasing power either of the em- 
ployers in the industry or of its customers, or of both. If 
any workers are displaced, it will take them time to find new 
emplo>TTient, and the new employment may be less remunera- 
tive than the old; some of them who are old or highly 
speciaUzed may be unable to find new employment at all; 
but somewhere or other there is an increased demand for 
labor due to the introduction of " labor-saving " machinery. 
When investigation of unemployment is made it is usually 
imcommon for an employed man to give the introduction of 
machinery as the cause of his unemployment ; even more 
conclusive is the fact that while labor-saving machinery has 
been steadily increasing in quantity for now over a century, 
and with increasing rapidity in the last forty years, there is 
no evidence that unemployment has increased or is increasing. 
The effect of machinery on wages we shall examine elsewhere. 

Using the Idle. — Exactly similar is the case of the 
employment of people who are not dependent on their work 
for a Hving. The rich girl who decides to work for her living 
is not necessarily " taking the bread out of the mouth of " 
some one else. Suppose she takes a post as teacher at $600 
a year ; her income is increased by $600 a year, she spends 
$600 a year more than she would otherwise have done; 

Q 



226 Economics for the General Reader 

there is $600 worth of demand for labor, capital, etc., more 
than there would have been if she had not begun to work. But 
what of the girl whom she has kept out of the post ? Would 
not she have earned $600 and offered the same demand for the 
goods and services of others ? True, and so long as she remains 
unemployed, the rich girl is displacing her; but does she 
remain unemployed? do we find as a matter of fact that as 
American women have forced their way into the professions 
and adopted the custom of working, the openings for poorer 
women have become less and unemployment among them 
greater? We do not, because the income which these rich 
girls are now earning is an additional demand for labor of all 
kinds ; their work adds to the real income of society and there- 
fore to the means that society has to pay additional workers. 

Increase of Population. — The case of the rich man's 
daughter is trivial, but it is exactly similar to an extremely 
important case, that of the addition to the population which a 
progressive society sees with every new generation. Every 
year in the United States fully 1,000,000 more human beings 
are born than die. That means that every year roughly 
1,000,000 more persons have to be made room for in industry 
and commerce ; employment and payment has to be found for 
nearly i ,000,000 new workers. Whence can this new employ- 
ment and payment come? Society is already spending or 
investing all its income, there are already unemployed workers. 
It can come from only one source, from the new workers. 
There are 1,000,000 people to feed, clothe, and amuse — 
plenty of employment there ; and there are close on 1,000,000 
more people producing and earning — a plentiful source of 
payment there ! Additional textile operatives are needed 
to clothe the new population, building operatives to house 
them, farmers to feed them; and the new population is 
these additional textile operatives, building operatives, and 
farmers. 

Flexibility of National Income. — The National Income is not 



The Circulation oj Wealth 227 

a fixed sum limiting employment to a fixed number of workers. 
There is always room for an increase in production, whether 
that increase be due to a new and more eflBicient machine, the 
labor of hitherto imoccupied workers, or the more efl5cient 
organization of the workers already in employment. There is 
always a demand for this additional product, because the 
addition to society's income enables society to pay the addi- 
tional workers or machines or organizers. In Dr. Marshall's 
words, the National Income or " National Dividend," as 
he prefers to call it, "is at once the aggregate net product of 
and the sole source of payment for all the agents of pro- 
duction." What we call " Supply " and " Demand " are the 
same things looked at from the different standpoints of con- 
sumer and producer; and consumers and producers are the 
same persons. The real National Income is the goods and 
services produced to satisfy the nation's wants ; it is these 
that land, labor, and capital produce, and it is with these that 
land, labor, and capital are paid : any increase in the product 
is an increase in the payments ; and the only reason why this is 
not obvious is that the separate producers exchange their 
product through the medium of money. Most people who 
receive an income contribute to production, either in their 
own persons by their work, or as owners of property which 
aids production. As producers they are highly specialized ; 
they want things they cannot produce themselves, and they 
obtain them by exchange. This exchange is the outcome of 
specialization, and is the fundamental thing in the present 
economic organization. 

Relation Between Supply and Demand. — It is only be- 
cause our exchanges are made through money that we have 
any difiiculty in perceiving that an increase in supply is 
(not " causes ") an increase in demand. If the community 
consisted of only four men, two farmers, a builder, and a 
weaver, and they exchanged their goods, then the weaver's 
supply of cloth would obviously constitute a demand for 



228 Economics for the General Reader 

buildings and food, the builder's supply of buildings a demand 
for cloth and food, the farmer's supply of food a demand for 
buildings and cloth. The same products are both supply 
and demand, according to the point of view from which we 
are looking. In the modern complicated community the 
same is the case. The weaver's supply of cloth is exchanged 
by him for gold, and the gold then exchanged for buildings 
and food; he sells cloth and buys buildings and food; his 
demand for house room and food is due to and is proportionate 
to his supply of cloth. If he makes more cloth he can buy a 
bigger house and more food, or if he does not want a bigger 
house and more food, he can buy something else. Thus an 
increase in the supply of cloth is an increase in the demand for 
other things; and vice versa, an increase in the supply of 
anything else may constitute an increase in the demand for 
cloth. What is divided among the members of society is the 
goods and services produced to satisfy its wants; and the 
same goods and services are both Supply and Demand. 

This exchange is independent of the way in which the 
value of the product is distributed among the factors of 
production. Whether capital, land, or labor gets it, it is a 
demand for other goods; because capitalist, worker, and 
land-owner all spend their incomes. It is sometimes sug- 
gested that the present economic system must come to an end 
because the workers do not receive in wages as much as they 
produce, so that they cannot buy back what has been pro- 
duced. That, if true, is a very bad thing ; but it would not 
supply an explanation of unemployment. If the workers do 
not spend the whole price of the product, some one else does ; 
it is spent. Goods are produced to be exchanged, and ex- 
changed they will be, whether by land-owner, capitalist, or 
laborer. 



CHAPTER XIII 

UNEMPLOYMENT AND OVERPRODUCTION 

I 

Imperfect Cooperation between Specialists 

Why Unemployment ? — The sketch of economic society 
that was drawn in the last chapter is defective in one important 
respect. Society is made up of specialized groups of producers, 
mutually dependent and engaged in the continuous exchange 
(through the medium of money) of their special products ; 
wealth takes the form of a continuous stream of goods and 
services, from which the means of production are constantly 
renewed and augmented ; new workers, new implements, 
new natural resources are constantly adding their contribution 
to the stream of goods and services, and by that contribution 
securing for themselves a place in the economic community 
and a claim on the stream. The sketch did not, however, 
indicate how there comes to be any unemployment ; how it 
comes about, in other words, that a system which regularly 
absorbs the new generation coming into industry every year 
is unable to absorb, however busy it may be, the whole of the 
workers who are willing and anxious to find work. Nor 
does it explain the regular recurrence of the related phenom- 
enon, which we call, according to the point of view, over- 
production or under-consumption. It would require a 
separate (and longer) work to deal with these latter problems 
adequately ; all that will be attempted in this chapter is to 

229 



230 Economics for the General Reader 

show that they are not inconsistent with the account of the 
working of the economic system, given in the last chapter, 
and that they are connected with principles of the system 
which we have studied in earlier chapters. 

Importance of Cooperation to Specialization. — The principle 
on which the whole system is based is specialization. Different 
kinds of labor, land, machinery, materials are all limited to 
one or a few uses, and in isolation are useless. The specialists 
must cooperate before they can produce anything of use. 
Whenever the cooperation is defective, the system will not 
work or will work badly. Specialization without cooperation 
then is the first great danger to which the present system of 
production is exposed. 

Defective Cooperation. — A single firm is an organization 
of specialized workers, specialized machines, specialized 
departments. In a well-organized and well-managed firm 
every worker, machine, and department cooperates har- 
moniously with every other ; all are fully occupied, without 
being overworked. But often the cooperation is not perfect ; 
one department, under-staffed or inadequately equipped, or 
for some other reason inefficient, mil hold up several other 
departments at one time, and compel them to work overtime 
to make up arrears at another ; just as a single weak back will 
let down a whole football team. In the single firm there is 
a general manager, whose business it is to see that all the 
departments of the firm work together evenly and regularly. 
But cooperation between specialized firms in an industry 
is as important in modern industry as cooperation between 
separate departments in a firm, and there are no general 
managers of whole industries. Weavers, spinners, wool- 
combers, wool-growers, and many others cooperate in the 
production of woolen fabrics ; their operations must have 
a certain proportion to one another, each stage of the industry 
must be adjusted to the wants and capacities of the other 
stages, or their cooperation will be defective. If the spinners 



Unemployment and Overproduction 231 

expand their business more rapidly than sheep-farming 
expands, they will presently find that there is a shortage of 
material, which will bring in its train short time or unemploy- 
ment for spinners' operatives, and also, though this is not 
a serious social problem, for spinning machinery. If the 
production of wool is increased and the manufacturers do not 
expand their plant in a corresponding degree, the spinners, 
though now able to get their material, will find themselves 
unable to dispose of their product, and there is overproduction 
of yarn. By the time the manufacturers are ready to take 
all the yarn that can be produced, the spinners and wool- 
growers, discouraged by the difficulty they have found in dis- 
posing of their product, may have reduced production — 
which involves unemployment or short time again for spinning- 
operatives and firms — and so a shortage of material for 
manufacturers and short time or unemployment for their 
operatives. Society relies on its organizers to secure the 
same cooperation between the different processes of one manu- 
facture in the hands of different firms, as the general manager 
secures between the different departments of his firm, and the 
organizers often fail. 

Difficulties in Way of Cooperation. — Within a single 
industry such disorganization should not be difficult to avoid ; 
in industry as a whole it occurs much more easily and fre- 
quently. An increase in the exports of certain manufactures 
may lead to an increased demand for ships to carry the exports ; 
the shipbuilding industry, responsive to this increased demand, 
enlarges its output. By the time the new ships are ready, 
however, three years may have elapsed and the need for the 
increased shipping have disappeared ; the result is a serious 
check to the shipbuilding industry. The different industries 
are one another's customers and colleagues ; an expansion 
of one, if it is not to be checked, calls for a corresponding 
expansion of others. But the different industries require 
different lengths of time for the delivery of their products. It is 



232 Economics for the General Reader 

difficult therefore to insure among them the harmonious 
cooperation which the modern industrial system requires. 

Immobility in Productive Factors. — A great difficulty In 
the way of securing perfect cooperation is the lack of mobility 
in the factors of production. There may be firms working 
below their full capacity for want of hands in one part of the 
country, while in another part men are on short time or un- 
able to find employment, through some purely local cause, 
such as the bankruptcy of an employer. It takes time for 
the owners of the idle machinery and the owners of the idle 
hands to find each other ; the object of the Labor Exchange 
is to enable them to find each other with the least possible 
trouble and delay. Normally the needs of an expanding 
industry are met by an increasing proportion of the new 
generation going into it, but there are only the begiimings of 
system of ascertaining where the new labor is wanted and 
directing the new generation in that direction ; boys and girls 
are constantly entering industries which will not want them 
in a few years. Again, the methods of industry are constantly 
changing. New processes, new material, new machines, 
new markets, new systems of organizing work, are constantly 
being adopted ; but labor, capital, and land are all specialized, 
and any change of method renders them, if not useless, at any 
rate less useful, until they can be adapted to the new methods. 
This takes time, and while it is taking place there will be im- 
employment and other dislocation. The loss of value which 
skill and machinery suffer by such changes of method are a 
kind of bad debt which society must write off before striking 
a balance of the advantages of specialization. 



Unemployment and Overproduction 233 

II 

Imperfect Anticipation of Demand 

Estimates as Basis of Production. — The second principle 
of the present organization that bears on the problems we 
are studying is the principle that production as a whole is 
carried on in anticipation of demand. Specialization has 
been carried so far, and has resulted in an organization so 
complex, that the production of most commodities begins 
many months before they are required. Individual firms 
may work to order or on contract, but that arrangement only 
shifts on to other shoulders the burden of anticipating what 
will be wanted. Whole industries may work to order ; the 
firms engaged in works of construction and engineering work 
almost entirely to order, and by varying their staffs to meet 
their requirements succeed in throwing the burden of meeting 
irregularities in the demand on to the shoulders least able to 
bear it, the shoulders of the workers. But these industries 
are engaged chiefly in supplying other industries with aids 
and facilities for production, and these other industries are 
working to meet a demand which has to be estimated, be- 
cause the process of production must begin before it is ex- 
pressed. The goal of most production is the retail counter, 
and the consumer expects to be able to get what he wants at 
that counter without giving notice beforehand. Production 
as a whole therefore is carried on on an estimate of demand. 

Stability of Demand. — The demand for most things is 
fairly stable, and we saw in Chapter IV that society has ways 
and means of estimating what demand is going to be. But 
mistakes are bound to be made. Things are made, which, 
when made, are not wanted, or are not wanted so much as 
other things that have not been made. The cooperation be- 
tween different specialists of the woolen industry may be 
perfect, and yet overproduction of woolen goods occur, 



234 Economics for the General Reader 

because the consuming public, for whom the woolen industry 
works, prefer to spend their incomes less on woolens and 
more on other things. When we consider the variety of 
goods ready for sale in retail shops and the complexity of the 
organization needed to produce each of them, and realize 
at the same time that that organization has been brought 
into being and applied to the production of the goods without 
any expressed demand for them, it becomes matter for sur- 
prise, not that the productive organization is occasionally mis- 
directed, but that it hits its mark so often as it does. 

Overproduction. — Let us be quite clear what we mean by 
overproduction. It does not mean that more of the article 
has been produced than can be consumed or used ; it does not 
even mean that more has been produced than can be sold. Any 
quantity of a thing that has a use can be sold, if the price 
be put low enough. What overproduction of an article 
means is that more of the article has been produced than can 
be sold at a price big enough to repay its makers the cost of 
production, plus sufficient profit to induce them to go on 
producing at the same rate ; all that has been produced can 
be sold, but only at a loss. The error may be in what the 
public wants ; a trifling error, perhaps, as when a fabric is 
produced that fails to capture the fashionable public's taste, 
or a new form of amusement is provided that does not " catch 
on " ; or a serious error, involving the uneconomical appli- 
cation of large resources, as on a railway which, when com- 
pleted, does not attract a sujB&cient density of traffic to make 
it pay. The important case, however, and the case which has 
most influence on trade fluctuations, is an error in anticipating 
how much the public wants. The leaders of an industry may 
anticipate exactly what is wanted, but produce it in excess of 
the public's demand. The income of the public is limited; 
it balances the satisfaction to be obtained from one thing 
against the satisfaction to be obtained from other things ; it 
can be induced to increase its purchases of a thing by a reduc- 



Unemployment and Overproduction 235 

tion in the price, it will usually restrict its purchases if the 
price is raised ; but at any price it will purchase only a certain 
amount of each thing, and if producers produce in excess of 
that amount they will be able to sell the whole of their out- 
put only by lowering the price. 

Effect of Competition. — The absence of any central con- 
trol of production encourages such overproduction. Each 
of a number of competing firms may anticipate accurately how 
much the public will take at a given price, and yet over- 
estimate the proportion of the total demand which competition 
will allow him to secure. The result is that each puts on the 
market more than his fair proportion, and the total amount 
put on the market is greater than the public will take at the 
price which the producers counted on getting ; one of the 
great advantages of trusts and combinations is, we saw, that 
it lessens the risk of committing this error of anticipation. 

Whatever the kind of error, however, errors of anticipa- 
tion are constantly beuig made, and their effect is always 
the same, the defective adjustment of supply to demand. 
If the supply put on the market is greater than the demand 
for the commodity at the price on which producers counted, 
the producers will have to reduce their price if they wish 
to sell their whole output. If they reduce their price, their 
profits will be less than they anticipated, and they vdW lessen 
production ; if they hold out for their price, they will be 
unable to sell their whole output, and the market will be 
glutted ; in either case there is a check to production. If 
the error of anticipation is in the opposite direction, and less 
is put on the market than the market will take at the antici- 
pated price, competition among buyers for this limited 
supply will force its price up, the higher price will yield 
profits higher than were anticipated, the higher profits will 
stimulate increased production, and the probability is that 
the relative scarcity will be succeeded by a relative excess, 
the stimulus to production by a check to production. The 



236 Economics for the General Reader 

stimulus to increase production carries with it its own antidote, 
since the increase in supply will tend to force prices down and 
so check production. Similarly, the check to production 
brings about its own correction ; things continue to wear out 
and stocks continue to be consumed, although the supply of 
new stocks has been checked ; the time comes when the public 
has to buy, and when that time comes, the relative scarcity of 
the depleted supply enables the producer to get his price. 

Summary. — To summarize, the price of a thing depends 
on the relation of the supply of it to the demand for it; if 
the supply is relatively small, the price will tend to rise, and 
the higher price will stimulate increased production, until the 
supply equals or exceeds the demand ; if the supply is rela- 
tively large, the price will tend to fall, and falling prices check 
production, until the price rises again. Overproduction 
and underproduction occur because: supply has to be adjusted 
to demand ahead of demand, on an estimate of it, not in 
response to an ascertained and definite demand. If the 
estimate is wrong, the price, on the basis of which production 
has been carried on, will not be realized, and the even flow of 
production will be dislocated ; it is the relation between the 
anticipated price and the realized price that matters. 

Ill 

Cyclical Trade Fluctuations 

Irregularity of Trade. — Alternating overproduction and 
scarcity, with their consequences, unemployment and over- 
time, can be put down in any single trade to the failure to 
anticipate demand accurately and adjust supply to demand 
evenly. Much more difficult to explain is the problem pre- 
sented by the fact that overproduction occurs, not in one 
industry at one time and in another at another time, but in 
all or most industries at the same time. The circulation of 



Unemployment and Overproduction 237 

wealth is subject to general fluctuations, the most marked 
symptoms of which are alternating periods of overtime and 
unemployment. At one time producers in all trades cannot 
work fast enough to satisfy the demands of the market, 
employers in all trades cannot get the operatives they want ; 
at another time producers in all trades cannot find a market 
for the goods they are producing, and employers in all trades 
dismiss or put on short time their operatives. What is the 
cause of this general movement up and down? Without 
pretending to offer a complete explanation, one or two sugges- 
tions may be put forward. 

Intertrade Dependence. — The separate trades are one 
another's customers, so that depression in one affects the 
others. Producers are also consumers ; if therefore the 
producers in one trade are getting lower wages and lower 
profits, they can spend less on the products of other trades. 
Conversely, if one trade revives, it will influence other trades ; 
its members, since they are selhng more, are able to buy more, 
and the improved demand for their goods and services is 
transmitted to other trades by their increased purchasing 
power. 

Psychological Factors. — This material bond between 
trades, however, is not enough to account for the rapidity 
with which depression or boom spreads from trade to trade 
over the whole field of industry. The connection seems to be 
psychological. The leading men in all trades are all looking 
ahead. Their estimate of future demand should be the 
result of a severely scientific balancing of evidence, backed 
by a specialized instinct born of long dealings with a certain 
market. To some extent it is that, but not altogether. Few 
men can resist the influence on their own opinions of the hopes 
and expectations of their associates. A market is a crowd, 
and has the psychological characteristic of the crowd, that 
the general opinion imposes itself on individual members with 
extraordinary force and rapidity. Hence if a strong opinion 



238 Economics for the General Reader 

is started — no matter how — that trade is improving, then 
that opinion will spread; the most level-headed operators 
will be influenced by it. Manufacturers will increase their 
output and pay higher prices for materials and higher wages 
to get more labor, since they anticipate no difiiculty in selling 
their goods, and the market will take any amount. And so 
long as every one is of this opinion, trade will be good. Ex- 
change goes on freely even at high prices, because the man who 
is buying at high prices is confident that, by the time he 
sells, prices will be higher still. Every trade, being busy, 
affords a brisk demand for the products of every other trade. 
In precisely the same way an opinion that demand is falling 
off will impose itself on the business community. The transi- 
tion from the one state of mind to the other may be brought 
about by chance ; a leading firm may take fright and begin 
to cut prices before its competitors ; other firms, observing its 
action, follow suit, and other trades, observing the fall of 
prices and consequent slackening of production in the one 
trade, are shaken out of their optimism. A great bankruptcy 
may turn the current of opinion, however unrelated the failure 
of the particular firm may be to the general course of trade ; 
the slump that follows a war, a wet season, the death of a 
monarch followed by general mourning, may any of them, by 
affecting one trade or set of trades, turn the tide. More 
usually it will be brought about not by chance but by the 
occurrence, almost inevitable in the present system of pro- 
duction, of overproduction in one or two trades, and opinion 
in them will infect opinion in industry generally. Once set 
in, the depression is accentuated by the refusal of sellers to 
lower prices. They hold out for the high prices which are 
now a thing of the past ; being unable to sell, they are unable to 
buy, and the circulation of wealth is checked until they give 
way. Improvement comes, in industry generally as in a 
single industry, when the consumption or wearing out of 
stocks, coupled with the checking of supply, forces prices up 



Unemployment and Overproduction 239 

again. It is helped by the fact that people, being unable 
during the depression to Hve on income, draw on savings and 
investments ; their savings being withdrawn from production, 
production is checked still further, and the rise in prices 
accelerated in consequence. Or production may be reduced 
by the weaker firms in each trade being unable to carry on 
business. 

Importance of Price. — This suggested explanation has 
been given more or less in the terms of the market ; to relate 
it to the sketch of industry given in the last chapter, it is 
necessary to eliminate the references to purchase, sale, and 
price, and to think of the transactions as exchanges of goods 
and services between groups of specialized producers — an 
aspect of them which the use of money as a medium of ex- 
change conceals. From this point of view we should say that 
producers can always find consumers who will give them some- 
thing in exchange for their products, but producer and con- 
simier cannot always agree on the terms of the exchange. 
The regular process of exchange is checked because the ex- 
changers cannot come to terms ; and exchange being checked, 
the production of wealth for exchange is checked. In a simple 
community the terms of exchange can be settled before pro- 
duction is commenced, and much production is not for ex- 
change at all ; hence there need be no misdirected production, 
and no overproduction with consequent unemployment. In 
the complex modern community production has to be com- 
menced long before the final exchange of products can be 
negotiated ; if the terms of exchange (the prices realized) dis- 
appoint anticipations, so that the organizers of production 
receive less in exchange for their products than they have 
expended in producing them, they will suspend or restrict 
production till they can get the terms they want. 

Physical Causes. — W. S. Jevons suggested another 
explanation for these fluctuations in trade. He observed 
that trade depressions recurred at fairly regular intervals ; he 



24© Economics for the General Reader 

observed also that the spots on the sun reached their maximum 
at about the same interval. His theory is that the initial 
cause of the depressions was a falling off in harvests, especially 
in tropical harvests, due to the falling off in the light and heat 
of the sun. Probably the physical cause contributes to the 
fluctuations; it is hardly enough to account for them al- 
together, even if the statistical basis for the conclusion were 
adequate. Especially it does not explain why most trades 
are affected simultaneously; the influence of a failure of 
tropical harvests would take some years to permeate industry. 
Credit and Speculation. — Two factors in the modern 
industrial organization may accentuate booms and depressions 
— the credit system and what we have called illegitimate 
speculation. The place of credit in the organization of pro- 
duction has been described in Chapter X. It is the chief 
source of the elasticity, the responsiveness to demand, of the 
modern productive organization. In a time of optimism 
banks and allied agencies give credit easily to business men, 
and so enable them to increase the amount of their business 
and to offer higher prices; in times of waning confidence 
banks, by restricting advances, deprive business men of an 
aid that is essential if they are to carry on business on their 
usual scale, and they depress prices. A sudden restriction of 
credit may even drive some firms into bankruptcy, and so 
shake confidence that not merely financial depression, but 
general industrial depression ensues. Probably no class 
therefore can do so much to exaggerate trade fluctuations 
as the bankers; a cautious and conservative policy in the 
giving of credit is essential to the stability not only of the 
banks and their allies, but of the whole industrial community. 
The present economic system is, in fact, too responsive to 
demand. The influence of the other factor, illegitimate 
speculation, will be inferred from what was said of it in Chapter 
IV. The honest dealer makes mistakes, and every mistake 
tends to accentuate price-fluctuations. The dishonest dealer, 



Unemployment and Overproduction 241 

who produces artificial price-fluctuations, does still more to 
accentuate them. The dealer, who deals on inadequate 
capital and makes a mistake, involves others in his ruin. The 
outsider, ignorant of the market and the material dealt in, 
is much more likely to make mistakes than the professional 
dealer. Every kind of illegitimate speculation tends to 
accentuate price-fluctuations, and therefore to make more 
difficult the task of anticipating demand and adjusting supply 
to it. 

The recurrence of overproduction, however, is connected 
with the fundamental principle of the present system of 
production, specialization, with its outcome, production in 
anticipation of demand. It is the great weakness of the 
system, as a productive organization, and its results are a 
heavy price to pay even for the wealth which specialization 
enables society to produce. The loss and suffering caused 
by trade-fluctuations are largely concentrated on the poor, 
and the sense of helplessness which unemployment brings 
to a man is an affliction of the spirit even heavier than the 
material loss that accompanies it. 



CHAPTER XIV 
VALUE 

I 

Value and Price 

Meaning of Value. — The general reader who opens a 
book on Economics is often puzzled by the great amount of 
space given to the Theory of Value. The reason is that the 
value of a thing is the rate at which it exchanges for other 
things, and in modern economic society almost all production 
is for exchange. The word " value " is in some respects 
an unfortunate term, since it is ambiguous. Take a few ex- 
amples of its use — " the value of diamonds," " the value of 
bread," " the value of a kitchen garden," " the value of 
prayer." Obviously it is not used in quite the same sense 
in all these examples. Yet, there must be some common 
meaning in the different cases, or the same word would not 
be used. If we try to say what this common fundamental 
meaning is, we probably express it best by the word " use- 
fulness " ; we attribute " value " to anything that has a use, 
anything that can satisfy a human want. But that is not 
the commonest sense in which we use the word. If we point 
to a house and ask its value, the answer we get will be 
given in dollars and cents, and the commonest of all 
the senses in which the word " value " is used is to denote 
the rate at which things exchange. It is in this sense that 
it is used in Economics ; a theory of value is an explanation 

242 



Value 243 

of the rates at which things exchange. Adam Smith dis- 
tinguished between the two chief senses of the word by the 
phrases " Value in Use " and " Value in Exchange " ; modern 
economists use the word " Utility " to denote Value in Use, 
and keep the word " Value " for " Value in Exchange." 

Money as Measure of Value. — Now the exchanges in which 
we are constantly engaged are not usually direct exchanges of 
goods for goods or services for services or goods for services — 
usually they take place through the medium of money. Since 
most exchanges are made in this way through money, money 
comes to be a general common standard of exchange rates, 
since everything is at some time or other exchanged for 
money; the amount of money for which it is exchanged 
becomes an indication of its value when compared with 
other things. Value is a ratio; for the sake of convenience 
the values of other things are expressed as ratios to money; 
consequently we speak and think usually not of values but 
of prices, the price of a thing being the amount of money 
for which a thing exchanges. There are certain advantages, 
however, in keeping to the term " value " in examining 
the principles of exchange. We do not speak of a thing 
having a price unless it is for sale; anything may be said 
to have a value whether it be for sale or not. Again, we 
feel that the price of a thing does not always represent its 
value. In the case of sale by a trick, or when one of the 
parties to a sale is under the influence of drink, price and 
value do not coincide ; such a phrase as " good value for 
money " is meaningless if price and value are necessarily 
the same thing. Such considerations are not important, 
prices are fairly representative of values at any given time ; 
but when we compare one time with another, for reasons 
explained in Chapter XI, a change in price is no evidence 
of change in value. 

Value and Price. — This possession of a general common 
measure of values in money is an enormous help in studying 



244 Economics for the General Reader 

them. At first sight it might seem impossible to compare the 
values of such different things as a surgeon's skill, an ounce 
of tobacco, a preacher's eloquence, and a loaf of bread ; yet, 
as a matter of fact, we do compare them. They are compared 
and measured and priced; and if we are rational beings, 
they are priced on some principle, their values are not for- 
tuitous. Their quaHtative differences are reduced to quan- 
titative differences; our individual estimates, our motives, 
are measured by the price we are willing to give for each. 
Moreover, if we can take prices as representative of values, 
we have got facts to start with. " A price is a fact. A value 
is an estimate of what a price ought to be " (Hadley). The 
price of a thing is a known thing, the same for every one — 
there can be no dispute about it ; the value of the same thing 
might be estimated differently by different people, their 
estimates varying with their moral and intellectual standards. 

Again, though prices are somehow or other the outcome 
of our estimates of the relative importance of things, they 
undoubtedly react strongly on our estimates. We are so 
used to associating high price with high quality that we 
sometimes refuse a good thing because its price is low. Fur- 
niture, clothes, hotels, and entertainments are often delib- 
erately made expensive in order to attract a certain class 
of buyer whose only criterion of quality is price. Espe- 
cially does price influence social judgments : in England and 
America a man's social rank is determined chiefly by his 
price or " income." The usage of ordinary speech convicts 
us of this snobbishness, since we say a man with an income of 
$50,000 a year is " worth " $50,000 a year though morally 
he may be " worthless." 

Prices then roughly measure values for us, but in making 
our study of the causes which settle the rates at which things 
exchange for one another, we prefer the wider term "value" 
to the narrower term "price " ; we aim at formulating "a theory 
of value," " a theory of prices " being quite another thing. 



Valtie 245 

What is the explanation of existing values ? why is a woolen 
shirt worth twice as much as a cotton shirt ? — questions 
such as these constitute the Problem of Value. 

t II 

The Labor Theory of Value 

Theories of Value. — There have been three theories of 
value of historical importance — the Labor Theory, the Cost 
of Production Theory, and the Marginal Utility Theory. 
The three theories have a common starting-point ; they agree, 
to quote Mill, that " the temporary or market value of a 
thing depends on the demand and supply; rising as the 
demand rises and falUng as the supply rises." But, Mill 
goes on, " besides their temporary value, things have also 
a permanent value, or as it may be called a Natural Value, 
to which the market value, after every variation, always 
tends to return ; and the oscillations compensate for one 
another, so that, on the average, commodities exchange 
at about their natural value." It is about this permanent, 
normal, or natural value that the theories differ. In this 
chapter we shall be concerned with the first two theories, 
which approach the problem from the side of supply, in 
the next with the Marginal UtiHty Theory, which approaches 
it from the side of demand. 

Statement of Labor Theory. — The chief exponents of the 
Labor Theory are Adam Smith, Ricardo, and Karl Marx. 
They hold that the value of a thing, in the long run, depends 
on the amount of labor embodied in it. " It is natural," 
says Adam Smith, " that what is usually the produce of two 
days' labor or two hours' labor should be worth double what 
is usually the produce of one day's or one hour's labor." 
Ricardo speaks of labor " as being the foundation of all 
value, and the relative quantity of labor as almost exclusively 



246 Economics for the General Reader 

determining the relative value of commodities." Marx puts 
the same simple theory in more difficult language; when 
we have abstracted all the individual qualities and proper- 
ties from commodities, " the residue . . .," he says, " con- 
sists of the same unsubstantial reality in each, a mere conge- 
lation of homogeneous human labor, of labor power expended 
without regard to the mode of its expenditure. . . . When 
looked at as crystals of this social substance common to them 
all (commodities) are — Values." Elsewhere he says " the 
value of a commodity is determined by the quantity of labor 
expended during its production." 

Utility under Labor Theory. — The holders of this theory 
recognize that a commodity must have utility, or use-value, 
to possess exchange-value, but they cannot see that the utility 
of a commodity has anything to do with fixing the amount 
of its exchange- value. Adam Smith points out — the para- 
dox of value — that goods with the greatest use-value have 
often a low exchange-value, while such things as diamonds 
with a high exchange-value have only a low use-value ; while 
Marx thinks that because the utilities of different commod- 
ities are different we cannot look to utility for a standard or 
basis of comparison for goods of different values. " As use- 
values," he says, " commodities are, above all, of different 
qualities, but as exchange-values they are merely different 
quantities, and consequently do not contain an atom of 
use-value." The theory allows also for the use of capital: 
machines and other forms of capital are " saved up labor " 
which is passed on to, and helps to determine the value of, 
the goods in the manufacture of which they are used. The 
greater influence which Smith and Ricardo allow to capital 
distinguishes their theory of value from that of Marx, and 
makes it approximate to the Cost of Production Theory. 

Difficulties of Labor Theory. — There is undoubtedly a 
general correspondence between the amount of labor re- 
quired to make a thing and its value, and competition among 



Value 247 

sellers tends to beat down value to cost of production, which, 
on the view of capital given above, is equivalent to the cost 
in labor. When an invention " saves labor " in the making 
of a thing, the thing's value usually falls. The theory is 
attractive also, because it seems just that the value of a 
thing should be fixed by the trouble or labor involved in mak- 
ing it. There are, however, great difficulties in the way of ac- 
cepting the theory as an explanation of existing values, and 
its simplicity disappears on closer examination. The chief 
difficulties are difficulties also of the Cost of Production 
Theory, and had better be deferred until that theory has 
been stated ; there is, however, one difficulty peculiar to the 
Labor Theory, namely, the meaning of the phrase " amount 
of Labor " ; that we will deal with now. 

What Is Labor? — Like so many of the terms which Eco- 
nomics has to take from ordinary speech, " Labor " has no 
single, definite, well-understood meaning. Do the upholders 
of the Labor Theory mean by " Labor " only manual labor? 
The use to which the theory is sometimes put implies as much. 
If so, they are ignoring the labors of organizer and inventor, 
which undoubtedly play a great part in the fixing of values. 
Again, within the province of manual labor, how do they 
compare skilled and unskilled labor? To what common 
measure do they reduce kinds of labor so different as the 
navvy's, the spinner's, the molder's, the grinder's? In 
the case of the same kind of labor, what do they take as 
their standard ? — for labor is not usually performed with 
equal efficiency by different laborers ; often the most valu- 
able things, especially in art and handicrafts, are made with 
least labor, since they are the work of workmen of special 
talent or genius, and in every trade the best workman is 
the man who can effect most with least effort — just as that 
batsman usually makes the longest hits whose strokes are 
least labored. 

Explaining the Difficulties. — The writers we have quoted 



248 Economics for the General Reader 

are conscious of these difficulties and attempt to meet them. 
"It is not very easy," says Smith, " to find any accurate 
measure either of hardship or ingenuity. In exchanging indeed 
the different productions of different sorts of labor for one 
another, some allowance is commonly made for both. It 
is adjusted, however, not by any accurate measure but by 
the higgling and bargaining of the market according to that 
sort of rough equality which, though not exact, is sufficient 
for carrying on the business of common life." Thus, though 
the value of a thing depends on the amount of labor in it, 
the amount of labor with which we must credit it is settled 
by the higgling of the market, in other words, by our old 
friend Supply and Demand. Ricardo ignores the difiiculty. 
" The estimation," he says, " in which different quaHties 
of labor are held comes soon to be adjusted in the market 
with sufficient precision for all practical purposes, and de- 
pends much on the practical skill of the laborer, and in- 
tensity of the labor performed. The scale, when once formed, 
is liable to little variation " — which is true, but does not 
explain which kind of labor he means when he speaks of the 
" amount of labor " determining value. 

The Marxian. — Marx tries several explanations. At one 
time he says : " The quantity of labor however is measured 
by its duration, and labor time in its turn finds its standard 
in weeks, days, and hours " — which, if true, would make it 
profitable to employ unskillful workers, since by taking 
longer over their work they would produce more value. In 
another place he takes unskilled labor as his standard : " We 
shall henceforth account every kind of labor to be unskilled, 
simple labor " ; in another place " average " labor : " The 
labor time socially necessary is that required to produce an 
article under the normal condition of production, and with 
the average degree of skill and intensity prevalent at the 
time " — i.e. the length of time actually spent by the laborer 
in producing an article has nothing to do with its value — its 



Valtie 249 

value depends on the amount of " socially necessary labor " 
that the worker succeeded in putting into it. Finally Marx 
adopts " simple, abstract human labor " or " socially 
necessary labor " as his standard. He is not, however, any 
more successful than Adam Smith in explaining why we 
must credit an hour's work of a cotton spinner with two 
and a half times as much " socially necessary labor " as an 
hour's work of a farm laborer ; all he can say is that 
" the different proportions in which different sorts of labor 
are reduced to unskilled labor as their standard, are es- 
tablished by a process that goes on behind the backs of the 
producers, and consequently appears to be fixed by custom." 
This is no reason why it should " go on behind the backs of " 
economic students. What this unseen process is, is indicated 
by Mr. Hyndman, Marx's chief English exponent, who says : 
" The quantity of labor incorporated is determined not 
actually, but relatively in equivalence with definite quantities 
of other commodities. This equivalence and therefore the 
social minimum of time required for production being de- 
termined by competition and the higgling of the market." 

Circular Reasoning. — The argument, though a Httle more 
roundabout, has brought us to the same goal as Adam Smith's 
argument : value depends on the amount of socially necessary 
labor in a thing, but the amount of socially necessary labor 
in a thing can only be settled by bringing the thing into the 
market and seeing for how much of other things it will ex- 
change ; but the rate at which it exchanges for other things 
is its value, so that all the argument has proved is that Value 
depends on Value. There is no unit or measure of labor 
which we can use as a standard of value ; " simple abstract 
human labor " is a perfectly justifiable concept, but then so 
also is " simple abstract human utility." There is no greater 
difference in kind or quality between the utility of a table 
and the utility of a tea-pot than there is between the labor 
of a cabinet-maker and the labor of a potter. To say that 



250 Economics for the General Reader 

labor is a very important element in the influences that fix 
values is true and important, but to exclude all other influences 
and attempt to make labor a standard of value leads inevitably 
to argument in a circle. 

Ill 

The Cost of Production Theory oj Value 

Explanation. — The other explanation of value that ap- 
proaches the problem from the side of supply is the Cost of 
Production Theory. It differs from the Labor Theory only 
in allowing for other elements besides labor in the cost of 
producing a thing, especially in allowing for profits, the 
remuneration of the capitaUst. " The cost of production," 
to quote Mill again, " together with the ordinary profits, 
may be called the necessary price or value of all things made 
by labor and capital." This conclusion is reached by ob- 
serving the effects of competition : if the value of a thing 
rises above its cost of production, its makers receive more 
than the average rate of profit, high profits attract more 
labor and capital into the trade, and the competition among 
sellers to sell the increased supply brings the value of the 
thing down; if the value of a thing falls below its cost of 
production, some of its makers reduce their production, or 
leave the trade, so that the supply is reduced, and buyers 
competing for the reduced supply force the value up again. 
In certain cases cost of production varies from producer to 
producer — owing, for instance, to variation in the fertihty 
of land or in proximity to markets ; to meet such cases the 
rule was restated, and value said to depend on " cost of pro- 
duction under the most disadvantageous existing circum- 
stances." The amount of a crop that society wants cannot 
be supplied from the best land alone ; inferior land has to be 
brought under cultivation. The cost of production on the 
inferior land is greater than on the good land; society has 



Valiie 251 

to pay a price high enough to cover this higher cost of pro- 
duction, or it will not be able to get as much as it wants, and 
all the producers are able to get this price. 

Difficulties. — Whichever form a theory takes that at- 
tempts to explain value from the side of supply, it has certain 
difficulties to face. First of all it ignores the possibility 
of misdirected labor. Labor and the other elements in the 
cost of production are constantly being applied to the pro- 
duction of commodities that possess, when made, little or 
no utility ; a large part of the organization of production 
is concerned solely with facing and averting this danger, 
and, as we have seen, failure is frequent. The cost of pro- 
duction of a suit that, when finished, does not fit, has nothing 
whatever to do with its value. In the fifties some of the 
Western States began the construction of railways. The 
embankments were built, but that is about as far as the 
railways got. The cost of production of these railway em- 
bankments ran up into the thousands ; their value was 
nothing. It is no answer to this difficulty to say, as Marx 
says, that the labor embodied in products of no utility " does 
not count " ; cost of production cannot be recovered if the 
thing produced turns out to be useless. What has cost of 
production to do with the values of summer hats at the end 
of the summer season, or of winter fashions at the spring 
sales? If it be urged that such cases are abnormal, one 
can only reply that they are of everyday occurrence. A 
country in which the cost of production invariably fixed 
the value of a thing would be a business man's paradise, 
because he would never be punished for his mistakes ; we 
ignore half our problem if we take utility for granted. 

Difficulty with Value Changes. — Similarly this group of 
theories does not explain changes in the value of a thing 
after it is made. Cost of production, whether measured in 
labor alone or not, is something settled and definite once a 
thing is produced — it belongs to the past and cannot be 



252 Economics for the General Reader 

changed; but values do change. So far as there is change 
in methods of production, it may be said that the cost of 
production, or the socially necessary labor embodied in a thing, 
can change even after the thing has been completed; but 
values change when there has been no change in methods of 
production. A death in the royal family will destroy the 
value, for that season at any rate, of whole stocks of dress 
goods ; house property decHnes in value in a " decayed " 
neighborhood without any change in the methods of build- 
ing houses : the gross annual value of lands in England (as 
returned under Schedule A of the Income Tax) fell from 
forty-eight and a half million pounds in 1879 to thirty-seven 
milhon pounds in 1893, Similarly values rise irrespective 
of cost of production. Building sites in great towns are 
the most obvious case, shares in successful corporations are 
another — the value of a company's buildings, plant, and 
materials depends not at all on their cost of production, but 
on the demand for the goods which the company makes. 
Such cases are far too numerous to be dismissed as " excep- 
tions " or with the statement that " in the long run " cost 
of production determines value. 

Unreproduceable Goods. — Still less will any Cost of Pro- 
duction Theory explain the " scarcity " values of works of 
art, favorable building sites, exceptional ability, etc. What 
of " dumped " goods ? Dumping is merely the appHcation 
of the principle of spring sales to foreign trade. How, again, 
can railway rates be explained on the Cost of Production 
Theory? The conclusion to which a study of Cost of Pro- 
duction theories of value leads us is that demand and utility, 
somehow or other, play a very important part in fixing values ; 
where value and cost of production or amount of labor do 
correspond, it would be just as true to say that the value of 
the thing decided how much labor, etc., shall be devoted to 
producing it, as to say that the amount of labor, etc., fixed 
its value. 



Valtie 253 

Actual Business Calculations. — An analysis of the ac- 
tion of the seller will lead us to the same conclusion. How 
does the business man settle the price which he charges for 
his goods? On what does the price he charges us depend? 
Can he charge anything he likes? Does he, as a matter of 
fact, fix his price by calculating the total cost of production 
and then adding, say, 10 per cent for his profit ? 

If the business man is not one of the leading men in the 
trade, if he cannot know with accuracy what the demand 
for his goods will be, or if he is doubtful about selling them 
at all, he probably will calculate the cost of them to himself, 
add something for his profit, and put them on the market 
at the resulting price. He will reason that his competitors 
will have costs of production about the same as his own, 
that they will want the same profit, and that they will be 
willing to sell at this price if he is not ; at the same time he 
cannot afford to take a lower price, even if some of his com- 
petitors, with lower costs of production or a bigger turn- 
over, can afford to. Taking business as a whole, however, 
this is not the invariable procedure. In retail trade stocks 
have sometimes to be cleared by " sales " for what they will 
fetch, or " leading h'nes " will be sold below full cost to at- 
tract customers ; in wholesale trade goods are often sold 
below full cost if the seller cannot sell them at any better 
price. 

Various Interpretations of Cost of Production. — Cost of 
production is a term that will bear more than one interpre- 
tation. A manufacturer will not sell below prime cost unless 
he is forced to realize some of his property by some sudden 
need for cash ; but he will often sell goods at a price that, 
after covering prime cost, makes only a small contribution 
to his standing expenses rather than let his works stand idle 
or allow competitors to cut into his market. Further, cost 
of production per unit varies with output : a producer will 
often quote a price for a large order below his present cost 



254 Economics for the General Reader 

of production, because he calculates that on the larger out- 
put his cost of production per unit will be smaller. Apart 
from this consideration, cost of production varies from firm 
to firm, from district to district : the efficient producer, 
who by successful organization can produce cheaper than his 
competitors, will not hand over the whole of his savings to 
the consumer in reduced prices — he will charge the highest 
price that the competition of other sellers will allow him to, 
and cheerfully pocket the big margin between cost of pro- 
duction and price that his cheap production leaves him. 

Difficulty of Calculating Costs, — Again, there are cases 
where the exact cost of production of any single piece of work 
cannot be calculated. The cost of running an extra excur- 
sion train on a railway, the cost of taking a return freight 
on a steamer that would otherwise have had to return in 
ballast, the cost to the doctor, lawyer, or stockbroker of any 
extra professional services, are cases in which prime cost can 
be calculated but total cost or real cost cannot : the railway 
has to be built and staffed to run even a single excursion train, 
the fares of the excursion ought to contribute to the expense 
of building and staffing it, yet all that expense would have 
been incurred even if that particular excursion train had not 
been run ; the steamer had to be built and equipped before 
it could undertake any freight at all, and every freight it 
takes ought to contribute to the cost of building and equip- 
ping it, yet the steamer was coming home without the return 
freight if it had not got it; the prof essional' man must have 
had his expensive training before he can undertake any pro- 
fessional services at all, yet once he has got the training an 
additional professional service makes practically no difference 
to his expenses. In such cases, then, the only possible prin- 
ciple on which the seller can proceed in fixing rates and prices 
is the railway company's principle of " charging what the 
traffic will bear." 

Cost as a Minimum Price. — Those producers who have 



Value 255 

any influence on the fixing of price usually do one of three 
things. First, they may work to order : a customer offers 
to take a certain quantity at a certain price ; the producer 
finds that his cost of production for that quantity is less than 
this price, and takes the order ; he does not tell his customer 
what his cost of production is — though he often tells him 
that the things " cannot be produced at the price." Or 
secondly, if the producer is not working to order, having made 
or arranged to make a certain quantity, he fixes the highest 
price for it that he thinks he can get — subsequently raising 
or lowering it according to the state in which he finds the 
market, perhaps also varying his price from customer to 
customer so far as he can do so without being found out ; 
the farmer, who has not complete control over the quantity 
of his output, has to adopt this procedure. Or thirdly, the 
producer may fix the price of his article first, and then 
make as much of it as he thinks will sell at the price ; a 
publisher for instance, having decided, to publish a book 
in a certain form at $1.50, has to decide whether he will 
publish an edition of one thousand, five thousand, or what- 
ever other number is usual. But whichever of these three 
courses the producer adopts, there is one rule that, so far 
as he is influenced by business motives, he invariably obeys : 
he gets what he can, he acts on the railway company's prin- 
ciple and " charges what the traffic will bear." The only 
difference between the railway company and most other 
producers is that other producers can estimate much more 
exactly than the railway company can what is the true and 
full cost of each piece of work, and they are much more sub- 
ject to competition. They do not, however, on that account 
fix their charges at cost of production ; they calculate cost 
of production carefully and take it as a minimum below which 
they will not let prices fall, and the competition of other 
sellers usually keeps them somewhere near that minimum ; 
but they get the highest price they can. 



256 Economics for the General Reader 

Importance of Leading Firms. — It is only the leading men 
of each trade who have much to do with the fixing of prices ; 
the great majority of sellers have to take prices for granted, 
producing as cheaply as they can and selling at the market 
price. In many industries, especially at the retailing end, 
there are traditional or customary prices, and what producers 
do is to vary the quality of the article which they will supply 
at the customary price — which comes to the same thing 
as varying the price of an article of standard or customary 
quality — or else they vary the quantity they will produce 
at the price ; in these variations, however, a few usually 
lead, the rank and file of the trade follows. 

IV 

Decreasing, Increasing, and Constant Cost 

Our analysis of the action of the seller, then, supports 
the conclusion of our previous argument, namely, that value 
cannot be explained from the side of supply alone. It also 
forces on our attention another consideration. The phrase 
*' Cost of Production " — like the word " Labor " — • con- 
ceals more difficulties than it explains. It is constantly 
used as if costs of production were always simple, fixed, and 
easily ascertained. This may have been the case once, 
but it is so no longer. Since the cost of production of any- 
thing is the chief element in determining its supply, we must 
try to get clear to ourselves the meaning of the phrase. 

Elements Entering into Costs. — Let us consider the 
elements in the cost of production as they present themselves 
to a modern manufacturer, and then consider the effects of 
a change in the volume of output. The first element is the 
cost of material; this can usually be ascertained with ac- 
curacy, though even here if many different materials are 
combined in the finished product the task is not easy. Next 



Value 257 

there is the cost of labor ; a large part of workshop manage- 
ment consists in devising means for ascertaining exactly 
what expenditure in wages is incurred on each piece of work 
done, and, if the commodity in its making passes through a 
great many hands, the task is ver>^ complicated. If we add 
to materials and labor any other expense that can be defi- 
nitely attributed to the given piece of work, we have what 
has been called the '* Prime Cost " of its production. Prime 
Cost, however, is never the total cost, and is often only a 
small part of the total cost of producing a commodity. Cer- 
tain " Supplementary " or " General " or ** Overhead " Ex- 
penses must be incurred to make it possible for the commodity 
to be produced. The firm must be organized, foremen and 
managers paid, whether much work or little is being done. 
Rent and wear and tear of buildings and machinery, the 
expense of the power plant, insurance against fire and acci- 
dent, taxes, are all necessary expenses, but none of them can 
be allocated to any particular unit of the whole output; 
oflice expenses and the expenses of the selling organization 
are largely independent of the amount of work done. Thus 
we have to include in the full cost of production of each article 
produced not only the cost of material and labor, but a pro- 
portion also of the general expenses of the firm, and that 
proportion will vary with the number of articles produced. 
In most big manufacturing firms the estimation of the cost 
of production requires the whole time of a specialized " costs " 
department. 

Similarly if we wish to arrive at the exact expense to society 
of the production of any commodity, we have to add together 
its Prime Cost of Production to each of the firms that handle 
it, a proportion of their General Expenses, the Prime Cost 
of transporting it and the materials of which it is made, and 
a proportion of the General Expenses of the different trans- 
port agencies, and a proportion of the expenses of all the 
merchants, bankers, shopkeepers, and others who assisted 



258 Economics for the General Reader 

in the collection, forwarding, and exchange of the materials and 
finished commodity. Dentists in presenting their accounts to 
clients, after stating the total amount of their charge, some- 
times add, " Details if required " ; if we were to ask for the 
details of all the payments for labor, materials, etc., that 
make up the $2.50 we were charged for our woolen shirt, we 
should be setting accountants a complicated task to perform. 

Possible Cost Movements : Diminishing Costs. — Bear- 
ing in mind the distinction between Prime Cost and Total 
Cost, we will examine the effect on Cost of Production of 
increasing the volume of production. There are three possible 
effects : the cost per unit may decrease, increase, or remain 
constant. In industry an increase in the volume of produc- 
tion (whether in the single firm or in the trade) usually brings 
with it a decreased cost of production per unit. There are 
two reasons for this. The first is that an increase in the 
volume of work makes it possible to carry specialization further 
— labor, machines, management can all be specialized further 
in the firm, while in the trade transport and marketing facili- 
ties can be specialized further, and subsidiary industries 
developed. The decrease in cost per unit owing to this 
cause will not be regular or continuous ; the cost will come 
down in steps, as it were, a drop taking place when a new ma- 
chine, a new system of workshop organization, a new method 
of distribution, or a new use for a by-product becomes 
practicable. And the decrease has a limit ; in the firm it is 
limited by the ability of the management; in the trade it 
is liable to be counteracted by increasing cost of raw material. 
The other reason for the decrease in cost that comes with an 
increased output is that the general, standing, or overhead 
expenses can be spread over a greater number of units of 
product. 

Increasing Costs. — In the extractive industries — agri- 
culture, mining, and fisheries — an increased output cannot 
usually be obtained at a decreased cost per unit, unless some 



Valtie 259 

improvement in methods of production is discovered. The 
two economies we have described do not operate so strongly 
as in industry, and are liable to be counteracted by the nig- 
gardliness of nature. The most convenient or fruitful lands 
are naturally occupied first, and if an increased supply is 
wanted, recourse must be had to inferior or less convenient 
soils. If the attempt is made to raise more by putting more 
work or capital into the land, the additional product will 
be raised only at an increased cost, so long as technical science 
remains the same; if we could always double the produce 
of our land by doubling our expenditure on it, we could raise 
all the food of the country on a single acre of land by doubh'ng 
often enough. We do not feel the effects of this niggard- 
liness of nature only because invention is constantly postpon- 
ing its pressure. In some industries also increased supply 
can be secured only at increasing cost ; in telephone service, 
for instance, an increased number of subscribers brings with 
it a more than proportionate increase in the complexity of 
the organization, and consequently in the cost of working. 
Transport in great centers of population has often, though 
for different reasons, to face the same difficulty. 

Constant Costs. — The third case, the case of constant 
cost, will occur when the influences making for economy 
are just counterbalanced by the difficulty of getting more 
raw material or by the increasing complexity of the business. 
It is also the rule with simple handicrafts, in which general 
expenses are unimportant. When handicraft was the rule, 
labor was the only important cost in production, and, since 
methods of industry and demand changed only slowly, the 
most important influence in fixing values. 

Complicated Nature of Costs. — Costs of production, then, 
are neither simple nor fixed ; our examination of them will 
help us to understand the influence of cost of production on 
value. The distinction between Prime Cost and Total 
Cost explains why producers are often willing to sell a por- 



26o Economics for the General Reader 

tion of their output at a price which does not cover the total 
cost of production. A heavy-steel works, for instance, has 
very high fixed expenses ; if it can recover the greater part 
of these fixed expenses by selling a portion of its output at 
a high price (for instance in a protected market), it will pay 
it to sell the rest of its output for a price much below its 
total cost of production, provided the price covers the prime 
cost, rather than not sell it at all. In times of trade depres- 
sion it may lose less by selling its whole output at less than 
total cost of production, provided the price more than covers 
prime costs, than by letting its works lie idle; in cases 
where the standing expenses bear a high proportion to the 
prime costs, selHng at a loss in this way may go on for years. 
In some industries the Prime Cost of any single commodity 
or service is so small in proportion to the Total Cost that 
cost of production affords no help at all to an understanding 
of the price charged. Such is the case with railways, water 
works and, in a less degree, gas works. In each case an 
enormously expensive plant has to be kept in working order, 
and interest earned on the cost of it, whether much or little 
business is done. In the case of railways the cost of con- 
structing the system is as much as ten times the annual 
receipts, and of the annual expenses 80 per cent have to be 
incurred independently of the amount of traffic. Under 
such circumstances it is impossible even for the manage- 
ment to say with any accuracy what is the true cost of run- 
ning a particular train or carrying a particular consignment 
of goods; the fuel, wear and tear and wages can be calcu- 
lated; beyond that, any estimate of cost must be more or 
less arbitrary. The prime cost is the only additional expense 
to the company for which this particular piece of work is 
responsible, but on its traffic as a whole the company has to 
charge fixed expenses amounting to 80 per cent of its whole 
expenses, and in addition any interest paid on the capital 
invested in the railway. 



Value 261 

The consideration that there are usually different costs 
of production (per unit) for different amounts of a com- 
modity is even more important. It helps us to understand 
the constant movement of prices. If a single manufacturer 
in a trade in which decreasing cost is the rule lowers prices, 
the rest must follow suit ; the lower price at which he offers 
the goods would otherwise attract his competitors' customers 
to him, and he can make a profit at the lower price since 
his larger output enables him to produce cheaper. As soon, 
however, as the available supply of raw material falls short, 
and — failing new inventions — the industry has to resort 
to less productive sources of raw material, the price has to 
go up, or the producers will not be able to keep their businesses 
going. 

When, therefore, we speak of supply, we must be quite 
clear whether we are dealing with a period long enough to 
give the supplying industry time to expand or contract, 
or a shorter period. Over the long period Total Cost is the 
important influence in fixing the amount of supply, over 
the shorter period Prime Cost is the important influence. 
We must be quite clear also that the word supply means 
a quantity at a price ; at different prices different amounts 
can be supplied by a producer or a trade without loss. It 
is theoretically possible to construct a supply schedule, 
giving the amount that can be supplied at each of a series of 
prices, or, what is the same thing, the prices at which each 
of a series of amounts can be supplied. Such a schedule 
would give us the prices or values towards which competition 
between sellers is constantly tending to drive commodities. 



262 Economics Jor the General Reader 



Influence of Competition and Monopoly on Value 

Possible and Actual Supply. — A consideration of cost of 
production does not, however, exhaust the influences affect- 
ing value on the side of supply. There is an ambiguity in 
the word " supply." By the supply of a commodity may 
be meant either of two things : the amount that could be 
brought to market, or the amount that is brought to market ; 
the amount that could he offered for sale or the amount that 
is offered for sale. Now the " supply " which will fix, or 
help to fix, the value of the thing is the amount that is offered ; 
while the " supply " which is determined by the cost of pro- 
duction is the amount which could be offered. The two 
amounts do not necessarily coincide ; whether they do or do 
not, depends on the control of the product, or, in other words, 
on the extent to which competition between producers is 
operative. In considering, therefore, the influence of 
" supply " in fixing values, the conditions of control are as 
important as the conditions of production; the conditions 
of production, as we have just seen, fix the cost of produc- 
tion, but the conditions of control fix the amount actually 
offered for sale. 

Monopoly Control. — The two extreme conditions of con- 
trol are complete monopoly and complete freedom of com- 
petition among sellers. The monopolist will work out the 
different costs of production for different amounts; he will 
estimate the demand at different prices ; he will then put 
on the market that amount which will afford him the greatest 
difference between total costs and total receipts. If — as 
would probably be the case in an industry subject to de- 
creasing cost — a small profit per unit on a large sale will 
give him a bigger total profit than a large profit per unit on 
a small sale, he will sell at the low price ; if — as would prob- 



Value 263 

ably be the case in an industry subject to increasing cost — 
a large profit per unit on a small sale would give the biggest 
total profit, he will limit his output. The amount that is 
put on the market will probably not be the amount that 
could be put on the market, and the price or value of the 
commodity will bear no definite relation to its cost of pro- 
duction. The profits of monopoly consist of this margin 
between cost of production and sale price, which the monop- 
olist is able to secure by his control of the supply. 

Free Competition. — At the other extreme, under per- 
fectly free competition, the amount that is offered will prob- 
ably be the whole amount that could be ofTered, and the 
value of the thing will keep pretty close to its cost of pro- 
duction. There is no single agent controlling supply and 
able to restrict it, however much higher the price that could 
be obtained for a restricted supply. The producers, compet- 
ing to sell, will none of them know exactly how much their 
competitors are putting on the market, and will hesitate to 
withhold a portion of their output, even if they think that 
the market is in danger of being glutted, for fear that their 
competitors will glut the market if they do not. They will 
none of them know what price their competitors will hold 
out for, and will therefore offer their product as near cost 
price as they can, for fear that their customer will take his 
custom elsewhere. We saw, when we were studying the 
meaning of competition, that the essence of it was the posses- 
sion of an alternative and the exercise of choice by one party 
to the contract of sale ; monopoly is the abohtion of the al- 
ternative and power of choice. 

Normal Situation. — Under free competition, then, the 
value of a thing will tend to coincide with its cost of produc- 
tion, and it has been usual- to take this as the normal case. 
It would be just as reasonable to take monopoly as the normal 
case. Perfectly free competition is as rare as complete 
monopoly; most actual cases in industry and commerce 



264 Economics for the General Reader 

fall between the two extremes. One of the chief aims of 
business men is to introduce some element of monopoly into 
their business, to impose some restriction on competition. 
Competition presses on them like a head of water, forcing 
down the price of their product towards its cost of produc- 
tion; any restriction they can impose on competition is a 
break-water, holding back the pressure and enabHng them to 
maintain an additional margin of profit between market 
value and cost of production. Further consideration of this 
must be postponed to the chapter on Profits ; it is sufficient 
here to note that perfectly free competition among producers 
is the exception, not the rule, and wherever there is any re- 
striction placed on competition among sellers, there is no 
surety that value will correspond with cost of production. 

Value Implied in Cost of Production. — There is one 
further obstacle to basing an explanation of values on the 
cost of production. The cost of production is itself reached 
by adding together a number of values ; it cannot determine 
value, since it is itself determined by value. The value of 
a manufactured article cannot be explained by its cost of pro- 
duction, because its cost of production depends on the 
values of the materials of which it is made, the value of the 
machinery used to make it, and the value of the time and 
energy spent by different workers upon it. To say that 
value in general depends on the cost of production is to say 
merely that one value depends on other values, which depend 
again on other values, and so on in a circle. The circle, how- 
ever, can be broken and the obstacle overcome — at the 
sacrifice of the simplicity and definiteness of the theory — 
by drawing a distinction between the expenses of production, 
which is what we have understood by cost of production 
hitherto, and the real cost of production, understanding by 
the real cost all the human efforts and sacrifices required to 
produce a commodity. The attraction of the Labor Theory 
lies in the fact that it bases value on the human effort re- 



Valtie 265 

quired to give value to anything, and so explains value in 
terms of human life. 

Sacrifice as Cost. — The Cost of Production Theory, 
however, brings out another element in real cost. Labor 
without the aid of the saved up products of previous labor is 
comparatively unproductive ; this " saving up " of wealth 
to aid further production does not go on without some in- 
ducement, since most people prefer spending to saving. We 
may say, then, that saving involves a sacrifice of sorts, which 
is just as much a necessary element in the real cost of pro- 
duction as is the effort of labor. Senior called this sacrifice 
"abstinence"; since the growth of great fortunes has made 
the term "abstinence" ridiculous, Dr. Marshall calls it "wait- 
ing." The sacrifice of the person who saves will seem negli- 
gible to the person who has to contribute to production the 
effort of labor, and quite rightly so ; still, under a system of 
private property, it has to be paid for, and the value of a 
thing must be big enough to induce the saving as well as the 
labor needed to produce it, or it will not be forthcoming. 
Hence in the real cost of production we must include all the 
efforts and sacrifices needed to produce a thing. 

This analysis of the meaning of " cost of production " 
and " supply " does not alter the fact that values cannot 
be explained by a consideration of the conditions of supply 
alone; it should, however, help us to understand the in- 
fluences on the side of supply which help to fix values. We 
have now to study demand. 



CHAPTER XV 

VALUE {Continued) 

I 

Relation of Utility to Value 

The Consumer's Viewpoint. — In the previous chapter we 
saw that value cannot be explained from the side of supply 
alone. An analysis of the action of sellers showed that they 
invariably (so far as they are influenced by business motives) 
act on the railway company's principle of " charging what the 
traffic will bear," of getting as good a price as they can from 
the buyer. How much then can the seller get? He can get 
just what the consumer will give. How much at a given 
price can the producer sell? He can sell just as much as 
the consumer will take at that price. The consumer has 
the deciding voice ; if he will not take the thing, he will not, 
and the producer, who has produced his things to sell, has 
them left on his hands. We have got to ask then what 
decides how much the consumer will pay, or how much he 
will take at a given price. 

Utility. — The answer seems simple ; the consumer will 
pay just as much, having regard to his income, as he thinks 
the thing is worth to him ; nothing can make him pay more, 
and it is the seller's business to see that he does not pay 
less. The consumer buys things because they satisfy his 
wants; he pays $2.50 for a woolen shirt because he thinks 
that he cannot get more satisfaction, a better $2.5o's worth, 
by buying anything else at the time. So the price which 

266 



Valtie 267 

the producer can get for an article depends on the satisfac- 
tion which the seller thinks he can get from the article, in 
other words, on the utility of the article. The producer, 
in fixing the price at which he will sell his product, or in fixing 
the amount which he will sell at a given price, is simply engaged 
in estimating (unconsciously of course) the utility of his 
product to the consuming public. He is not quite restricted 
to the task of estimating utility, he can do something to in- 
fluence the consumer's opinion of utility; we said that the 
consumer will pay just as much as he thinks the thing is 
worth to him, and a whole army of agents, advertisers, and 
others are employed in this work of influencing consumers' 
opinions ; but ultimately things are bought because they 
satisfy wants ; however consumers' opinions may be in- 
fluenced, consumers buy things because at the time they buy 
them they want them. 

Variability of Utility. — It seems, then, that value depends 
on utility ; before we can accept this view as an explanation 
of value, we have two difiiculties to overcome. The first 
is that the utility of a thing is different at different times and 
to different persons, while its value may remain the same. 
A loaf costs the same to the starving man, who spends his 
last nickel upon it, and to the dyspeptic millionaire, who 
could afford to give a thousand dollars for it, but will not 
be able to enjoy it when he gets it. The utility of a loaf 
is different to the two buyers, the price is the same. When 
we are hungry a loaf has a greater utility for us than when 
we are full ; we do not therefore pay a higher price for it. 
The reason for this uniformity of price or value is that the 
loaf is bought in a competitive market. If sellers could 
charge us according to our need, they would probably do so ; 
but there cannot be any great variations of price for the 
same article in the same market ; if the baker tried to charge 
us eight cents for a five cent loaf just because we were hungry, 
we should go to another baker. Competition among sellers 



268 Economics for the General Reader 

then generally insures that an article shall have one price 
to all buyers in spite of the different utilities it has to different 
buyers. A monopolist could charge different prices to dif- 
ferent customers; wherever there is an agreement, exphcit 
or tacit, among all the people in a trade or profession, different 
prices can be charged — doctors for instance make different 
charges for the same services according to the income and 
social position of their patients — but in most trades there 
is enough competition among sellers to insure that the price 
of a commodity will not vary much in the same market. 

Relation between Utility and Supply. — The other diffi- 
culty is greater; so great is it that, as we have seen, the 
earher economists decided that they must ignore utility in 
looking for the principle governing values and look exclusively 
to the side of supply. Utility and value seem to vary in- 
versely with each other; commodities such as bread, air, 
water, with the greatest utility — or, as Adam Smith called 
it, value in use — have often the lowest value in exchange, 
and conversely commodities with the highest value in ex- 
change, such as diamonds, rare curiosities, and pictures, seem 
to have little utiUty. The importance of the want satisfied 
by a commodity seems to have no influence on its value. 
The explanation of the difficulty lies in the fact that the 
utility of the total supply of a commodity is a very different thing 
from the utility of a given quantity of it, and it is the latter that 
we consider when we are comparing and measuring values. 
The entire supply of bread, water, or air is obviously of in- 
finitely greater utility than the entire supply of diamonds or 
pictures ; but entire supplies do not come into the market ; what 
the consumer considers in making purchases is a little more 
of this or a little more of that. It is not the utility of water 
to us that we measure in fixing our price for it, but the utility 
of an extra tap in the garden or a lavatory on the ground floor ; 
it is not the utility of bread that we measure in deciding what 
price we can pay, but the satisfaction to be obtained from 



Valtce 269 

an extra loaf a week. And it is this " little more or less," 
in Dr. Wicksteed's phrase, that we consider in comparing 
the desirability or utility of different commodities. In 
choosing our residence we hesitate between a little more 
fresh air, to be obtained by living in the country and paying 
railway fares to our work, and greater proximity to our work ; 
we hesitate between an addition to our collection of books 
and an addition to our furniture, between an extra ounce of 
tobacco a week and an additional subscription to the Red 
Cross. 

n 

The Marginal Utility Theory of Value 

Diminishing Utility. — It is always a little more or less, 
never the commodity as a whole, that we consider ; more 
food, more house-room, more clothes, more recreation, and 
amusements ; the poorest of us have already somg food, some 
shelter, some clothes, some recreation. And every additioii 
to our supply of anything gives us a smaller satisfaction than 
the previous addition ; the more we have of a thing, the less 
we gain by adding to our store of it. If we already have 
three good meals a day, an additional meal will give us less 
satisfaction than the extra meal would give if we were in- 
creasing our meals from two to three ; if we live in a ten- 
room house and move into an eleven-room house, the addi- 
tional room gives less satisfaction than it would do if we were 
moving from a four-room house ; if we already have a summer 
suit, winter suit, dress suit and flannels, the opportunity of 
getting another suit will not appeal to us as it would do to a 
man with only one suit at present ; if we are members of 
ten clubs, possess three motors, a yacht, and a country house, 
and can take a box at the theater whenever we want to, we 
shall not attach the same importance to a gallery ticket ad- 
mitting to a moving-picture entertainment that a working 



270 Economics for the General Reader 

lad does with only a quarter a week pocket-money. All 
wants tend to satiety; if we have too much of a thing, we 
get, in the common phrase, " fed up." There are apparent 
exceptions; alcohol stimulates the appetite which it feeds, 
but even alcohol, if administered continuously, will sooner 
or later make the drinker sick. It is sometimes said that 
the appetite for money is insatiable ; it is not ; the wants 
that money enables us to satisfy are so many and varied 
that we can find a use for money almost indefinitely, but 
for money itself, the coins, the appetite is not insatiable 
except in the case of that rare person the true miser, who 
is significantly called " abnormal." Wants differ very much 
in the rate at which they become satiated; intellectual 
wants are usually satisfied much more slowly than physical 
wants ; but all wants tend to satiety. If it is asked why, 
we can only answer that it is a fundamental fact of our human 
nature. 

Diminishing Utility and Value. — Let us apply this " law 
of diminishing utility " or " satiable wants " to the fixing 
of values. A pound of tea a week gives us a great satisfac- 
tion, we would willingly pay $1.75 for it rather than go with- 
out it; a second pound of tea does not give us the same 
satisfaction, we would not give more than $1 for it ; a third 
pound gives less satisfaction still, we would give 50 cents for 
it but no more. But the pounds of tea are all alike, one in 
itself is as good as another, the difference in the amount of 
satisfaction they give is due to us. Further, there cannot 
be two prices for the same article in a competitive market ; 
all the pounds of tea of a given quality will have the same 
market value. Consequently the seller of the tea will not 
be able to charge us $1.75 for the first pound, $1 for the 
second, and 50 cents for the third ; if he wishes to sell us two 
pounds he can charge only $1 a pound, while if he wishes to 
sell us three pounds he will have to reduce his price to 50 cents 
a pound. It is the utility of the pound of tea that we are 



Value 271 

just induced to purchase that settles the value of tea for us ; 
the total utility of tea has nothing to do with fixing its value, 
it is the utility of the Httle more or little less that we just find 
it worth while or not worth while to purchase that settles 
its value. To this " little more or Httle less " the term 
" marginal " has been apphed, and its utility is the " mar- 
ginal utility " of tea. Market values coincide with marginal 
utility} 

Significance of the Marginal Conception. — The impor- 
tance of this theory lies in the explanation it gives us of two 
otherwise inexplicable facts, the fact that the things with 
the greatest importance to life have often the lowest market 
value, and the fact, recognized by every one and understood 
by so few, that an increase in supply brings usually a fall in 
value. Important things like bread have a low value be- 
cause most people have plenty, and sellers can only induce 
us to take all they produce by putting the price low. The 
total utility of bread is immense, but does not affect its value ; 
the utility of the loaves which a well-fed public are only just 
induced to buy is so low that the consumers will not pay more 
than 5 cents the loaf. The world could get on very well with- 
out any diamonds at all ; yet the desire for display, which 
diamonds satisfy, is so far from being satisfied among the rich 
people who wear diamonds that they estimate at a very high 

^ It should be borne in mind that there are two "margins" in economic 
theory ; first, the margin which is the result of competition, the margin meant 
in such phrases as "the margin of cultivation" and "the margin of production" ; 
and, second, the margin which is the correlative of the principle of diminishing 
utility, the margin referred to when the phrase "marginal purchase" is used to 
describe the third pound of tea a week which satisfies a want just strong enough 
to induce us to purchase it at 50 cents. The first is a market margin, i.e. 
it is the result of differences among a large number of individual producers who 
are getting the same market price for their product ; the second is an individual 
or psychological margin, i.e. it is the result of the differences between the satis- 
factions given by successive pounds of the same tea. The two "margins" are 
often confused ; the marginal utility theory of value is concerned solely with the 
second. 



272 Economics for the General Reader 

value the satisfaction to be obtained from another diamond, 
and pay accordingly. Again, if the supply of anything is 
increased, the value will fall, because the additional supply 
satisfies a less intense want than the previous supply. Each 
person using or consuming the thing was already bu3dng as 
much, at the old price, as the satisfaction it gave was worth 
to him; every one will take an additional supply (which, 
in accordance with the principle of diminishing utility, will 
give less satisfaction) only at a lower price. For each in- 
dividual the market-price is a thing given and fixed, each 
decides how much he will buy at that price. But from the 
standpoint of the outside observer, the market-price itself 
is the result of all the individual valuations, since that price 
has been chosen by 'the sellers as being the price at which they 
could sell most at a profit. The price is fixed by the seller 
in the first instance, but in fixing the price he is unconsciously 
estimating the marginal utility of his commodity to the con- 
sumers. 

Derived Value. — A great part of the wealth of a modern 
community consists of machines and other aids to production 
which satisfy no want directly. Their value is derived from 
the value of the goods ready for consumption which they 
help to produce. If the demand for their products goes up, 
their value will rise with the value of their products ; if the 
supply of their products is increased, without any corre- 
sponding increase in the demand, their value will fall with 
the value of the products. Similarly the value of labor and 
of land are " derived " from the value of the goods they 
produce. 

Historical Background of Value Theories. — The three 
historical theories of value reflect the conditions of industry 
at the times they were formulated. The Labor Theory ex- 
plained values fairly well at a time when the division of labor 
was simple, and there was little power machinery and little 
trade ; manual labor was the only important element in the 



Value 273 

cost of production, and in the narrow markets for which the 
laborer worked " allowance " was easily made for " hard- 
ship and ingenuity." When methods of production became 
more complicated, especially by the extensive use of power- 
machinery, it was felt that labor alone was not a sufficient 
explanation, and " Cost of Production " was substituted ; 
factories were still comparatively simple and confined to a 
narrow range of products, the cost of which could be easily 
separated and computed. The typical modern firm includes 
many products in its output, the costs of which cannot al- 
ways be analyzed and computed separately ; hence " Cost of 
Production " is no longer an adequate explanation of values. 
No Cost of Production theory would ever explain why steak 
has a greater value than shin-beef from the same beast ; to- 
day the commodities which are supplied jointly, like steak 
and shin-beef, are innumerable, and any theory of value to 
be any use must account for their values. 

Ill 

The Law of Supply and Demand 

Our hasty survey of the chief historical theories of value 
has brought us back to our starting-place, supply and de- 
mand ; it has not on that account been waste of time. We 
have learned that there is no objective standard or measure 
of values except money ; any attempt to find an absolute 
standard in labor or cost of production leads to a circle in 
argument, for labor and all the other elements in cost of 
production themselves are valued and cannot therefore be 
used to value other things. We have also found that to 
ignore market values and try to find some " natural," " per- 
manent," or " normal " value is rather a waste of time. 
Market values are the only values ever expressed as prices; 
our only facts, therefore, are facts of market values, and 



274 Economics for the General Reader 

market values are the only values that practically affect 
us. We have also learned something about cost of produc- 
tion, and something about demand; the Marginal Utility 
theory is only a more exact statement of the principle that 
value depends on supply and demand. We are now in a 
position to sum up our knowledge of supply and demand, 
and to realize the significance of the statement that value 
depends on supply and demand. 

Misapplication of Supply and Demand. — It was said in 
the middle of the last century that you could make a good 
economist of a parrot by teaching it to repeat the words 
" supply and demand " ; a great many people have acted 
on this belief, and, having taught themselves to repeat, like 
parrots, the words " supply and demand," have set up for 
economists. In spite of frequent misuse, however, the prin- 
ciple that value depends on supply and demand is extremely 
important; a parrot that fully understood it would indeed 
be a good economist, but it seems to be beyond the compre- 
hension of most parrots, human and otherwise. The principle 
does not mean that if we knew how much of a commodity 
was in existence and how much was wanted, we should be 
able to calculate its value ; desire for a thing has no influence 
on its value unless it is backed by the will and ability to pur- 
chase, and the supply of it has no influence on its value un- 
less its owner is willing to sell. 

Explanation of Supply and Demand. — The supply of a 
thing, in the phrase " supply and demand," is the amount 
that will be offered for sale at each of a series of prices ; the 
demand is the amount that will be bought at each of a series 
of prices. The principle that value depends on supply and 
demand means that in the case of nearly every commodity, 
more will be bought if the price is lowered, less will be bought 
if the price is raised. Therefore sellers, if they wish to in- 
duce buyers to take more of a commodity than they are 
already doing, must reduce its price ; if they raise its price, 



Valtie 275 

they will sell less. If there is a general falling ofif in demand 
— due, say, to trade depression — sellers will either have to 
reduce prices or put less on the market ; they will not be 
able to sell the same amount at the same price. Similarly 
with supply. At a certain price a certain amount will be 
offered for sale, at a higher price more will be offered, at a 
lower price less. If consumers want more, they must offer 
a higher price ; if they want less, they will probably be able 
to force prices down. That is the first result of a change in 
demand or supply. 

Mutual Relationship of Value and of Supply and Demand. — 
The statement *' value depends on supply and demand," how- 
ever, does not express the whole truth ; it would be equally 
true to say " supply and demand depend on value." If there 
is a change in demand, sellers will increase or reduce supply 
to suit the demand, so that prices resume their old level ; 
if the sellers who control the supply anticipate exactly the 
changes beforehand, there will be no fluctuations in the value 
of the commodity at all. Similarly, if sellers reduce the 
supply and so send the value up, the increased value will 
check the demand and perhaps force the sellers to reduce 
prices again. Supply, demand, and value depend on one 
another ; if one changes, the other two will be affected ; or a 
change in supply may be balanced by a change in demand, 
and value remain the same. 

Elasticity of Supply and Demand. — In considering the 
supply of anything, we have to take into account the possi- 
bilities of the industry that produces it : if it is an industry 
in which an increased output means a decreased cost per 
unit, then the sellers may find themselves able to meet a 
bigger demand at the lower price ; if, on the other hand, the 
commodity is one in which an increased output can be ob- 
tained only at an increased cost per unit, then the sellers may 
find it pays them to reduce the output and raise the price. 
In considering demand we must remember that, while it 



276 Economics for the General Reader 

nearly always increases as price falls, the increase may be 
much or little in proportion to the fall in price ; in the case 
of common luxuries and commodities capable of many uses, 
the consumption may be stimulated greatly by a small re- 
duction in price, the demand is, in technical phraseology, 
" elastic " ; in the case of necessities, such as bread, of which 
most people have as much as they want, a large reduction 
in price may produce a very small increase in consumption, 
the demand is " inelastic." The elasticity of demand is also 
affected by the class of consumer to which the commodity 
appeals. 

The important influences then in determining the value of 
a thing are the nature of the supply of it — whether subject 
to increasing, decreasing, or constant cost — and the elas- 
ticity of the demand for it. Further, if we wish to get be- 
hind the actions and reactions of the market, and to state 
the influences that fix value in terms of human life, we shall 
still say that value depends on supply and demand ; but 
just as demand depends on the power of the commodity 
to satisfy human wants, so supply, in its turn, depends on 
the true cost of production, i.e. on all the human efforts 
and sacrifices needed to produce a thing — for nothing has 
value that can be obtained without effort or sacrifice. Value, 
in M. Pareto's phrase, " arises from the contrast between 
tastes and obstacles." 

Value and Production. — This principle that valwe de- 
pends on supply and demand, or rather that value, supply, 
and demand are interdependent, gives us the clew to the 
movements of the market. We have seen its fundamental 
importance in our study of commerce in Chapter III and 
Chapter IV, and in our study of trade fluctuations in Chapter 
XIII. Value is the automatic indicator which production 
follows. If the want for a thing grows more intense, its 
demand rises, and therefore its value rises. The higher 
value induces producers to increase production, the supply 



Value Y ( 277 \ 

' \ , ^ 

is increased until it equals the demand, with the result that 
the value falls to its old level. Or suppose pcoducers produce 
a thing in excess of the want for it, then its value will fall; 
warned by the fall in value they will reduce the production 
of it, and with the reduction in supply, its value rises to the 
old level. A high value indicates that a thing is wanted 
much by the people who can pay for it, it also stimulates the 
supply of it ; a fall in value indicates that no more of a thing 
is wanted by the people who can pay for it, and at the same 
time discourages the further supply of it. Thus value comes 
to represent an equihbrium between production and wants, 
and one of the chief functions of the organizers of industry is 
to restore this equilibrium whenever it is disturbed. 

Monopoly and Supply and Demand. — This interdepend- 
ence of value, supply, and demand is not inconsistent with 
the fixing of prices by monopolists or the State. If a monop- 
olist fixes a price, the demand adjusts itself to the price, and 
the monopolist will have to limit supply to the amount of 
that demand ; if he raises the price he will have to restrict 
his output ; if he wishes to increase his output, he will have to 
reduce the price in order to induce the public to take the in- 
creased supply. Similarly, if the State fixes the price, de- 
mand and supply adjust themselves to it ; when for example 
it fixes taxicab fares at 50 cents a mile, it restricts the supply 
of taxicabs to those firms which can afford to ply them at 
50 cents a mile, and restricts the use of them to those people 
who can afford to pay 50 cents a mile. If it raises its authorized 
price, it encourages supply and checks demand ; if it lowers 
the price, it stimulates demand and, for the moment at any 
rate, checks supply. A constant extension therefore of the 
State's regulating activity is possible, in the way of fixing 
prices and wages, without substituting for the present " law 
of supply and demand " any different operative principle 
for the direction of production. Such an extension is taking 
place, and the effect of it is to substitute formal and public 



278 Economics for the General Reader 

correlation of supply and demand for the haphazard private 
methods of ordinary commerce. The interdependence of 
value, supply and demand would cease to be operative only 
if the State, substituting public for private initiative through- 
out the economic organization, decided what should be pro- 
duced, what work every one should do, how capital should be 
accumulated and applied, and land used, and how all goods 
and services produced should be distributed. 

Note. — The activities of the State during war, especially in Germany, 
show that the alternative indicated to the present system is not an impossible 
or inconceivable one. 



CHAPTER XVI 
' WAGES 
I 

Wages and Income 

Money Wages. — A workman, asked what his wages are, 
will probably answer with some such phrase as " twenty dollars 
a week." That is the return he gets for his labor, that is the 
value that society has put on his energy and skill ; the problem 
of wages for the economist is to discover how society came to 
put just that value on the workman's labor. Before, how- 
ever, we can examine the chief solutions that have been 
offered to this problem, we must understand what wages 
are, how much, in fact, we know about a man when he has 
told us that his wages are twenty dollars a week. 

Time and Piece Wages. — Labor is paid for in many 
different ways, the two chief being by Time Wages and by 
Piece Wages. Presumably the employer endeavors to get the 
same amount of labor for his money whichever method he 
adopts. When the work is uniform and output can easily 
be measured, he usually prefers to pay the workman a fixed 
price per piece. In the textile industries the settlement of the 
price to be paid between workman and employer is often a 
difficult matter; the calculation of wages from price-lists 
may be very complicated, the wage being the resultant of 
several variables. If a basis for piece rates, however, can be 
reached, the employer is relieved of the task of " driving " his 

379 



28o Economics for the General Reader 

workmen; since their wages depend on their output, they 
" drive " themselves. Some of the money saved in foremen's 
wages is usually spent in paying inspectors to examine the 
work and reject what is faulty. In many occupations, how- 
ever, the work is so varied that there can be no standard by 
which the output of the worker can be measured, in others 
the quality of the work suffers when the worker is paid by 
the piece ; in such cases the employer will pay the worker 
by the amount of time he takes over the work, and pay 
foremen to see that the worker does not waste his time. There 
are many variations and combinations of these two simple 
methods of paying for labor. In some occupations, again, 
payment for labor is made partly in kind, and the value of 
such receipts in kind must be reckoned in calculating the true 
wage : the agricultural laborer has often a cottage or garden 
at less than its full rent, the domestic servant receives board 
and lodging in addition to her money wage. In other occu- 
pations, such as the mason's and the grinder's, some deduction 
for trade expenses has to be made from the weekly wage 
before the true money wage is reached. 

Regularity of Work and Wages. — The weekly wage, 
however calculated, is very far from giving the true economic 
position of the worker; not the wage-rate but the income 
actually received determines his position. Hence the 
regularity or irregularity of work is a most important con- 
sideration in comparing the advantages of different occupa- 
tions. Many casual workers are paid at a good rate while 
they are working, but their opportunities of work are so inter- 
mittent that their average weekly earnings are low and their 
economic condition correspondingly bad. The London Dockers 
in 1889, though they secured the sixpence per hour for which 
they struck, failed to make their occupation a tolerable one ; 
they did nothing to secure that each worker should have a 
sufficient number of hours of work each week to enable him 
to earn a sufficient number of sixpences to keep a family. 



Wages 281 

Similarly in seasonal trades (including all trades afifected by 
weather or fashion), the earnings of nine months may have 
to keep the worker during twelve months ; the weekly wages 
may be comparatively high, while the annual income is com- 
paratively low. The economic position of the worker in 
such a case can only be represented by the average obtained 
by adding together the earnings of the whole year, bad 
weeks and good weeks together, and dividing by fifty-two. 
The important thing is not what the trade pays the worker 
for an hour's work or a week's work, but what it pays him 
for his services as a whole ; the worker and his family have 
to live for fifty-two weeks, even if the trade only uses his 
services for forty weeks. In the case of trades subject to 
considerable cyclical fluctuations, such as the ship-building 
trade, the average weekly wage has to be calculated over an 
even longer period. A worker may work overtime for 
eighteen months and then be on short time or without work 
for another eighteen months ; his true money wage is his 
average weekly earnings over the whole period. 

Conditions of Employment and Wages. — Perhaps we may 
go further and average a man's earnings not over a week or a 
year or three years, but over a lifetime, and that not over the 
length of time he actually lives, but over the length of time a 
man ought to live if the conditions of his work are healthy. A 
trade employs a man, he adapts himself to its needs and there- 
by unfits himself for other work ; he is dependent on the trade 
for a livehhood, and his true rate of wages is the amount of 
his earnings divided by the number of weeks he has to live on 
them. This is not commonly recognized : a wage is called a 
" good wage " if the rate of payment per week is high, though 
the employer may be exacting an amount of work from the 
worker so great that the man is " too old at forty." In the 
Heavy Steel Trade of Pittsburg, that industrial paradise, 
wages are " high," but one man in three works twelve hours a 
day, seven days a week, and, once a fortnight, twenty-four 



282 Economics for the General Reader 

hours on end ; in the corresponding occupations in England the 
wages earned are not more than half as much, but the working 
life is longer, so that the total earnings are probably not 
much less. Conditions of employment vary not only from 
trade to trade, but from firm to firm in the same trade; 
an employer can frequently, by offering a wage sUghtly 
higher than his competitors pay, or by his efiiciency or the 
efficiency of his subordinates as slave-drivers, induce his 
workmen to work themselves " out " by the age of forty. In 
such cases the true rate of wages should be calculated by 
adding up the worker's earnings and dividing the total, not 
by the twenty-five years he did work, but by the fifty years 
his working life ought to have lasted ; " higher " wages when 
treated this way will often become low wages. Similarly 
allowance must be made in the case of dangerous or unhealthy 
trades for periods of illness ; in the case, for example, of high 
school teachers, for the expense of an occasional nervous break- 
down. 

The " Family Wage." — The distinction between income 
and wage emerges in another connection. The worker's 
wages is what he earns himself, the income on which his family 
can draw usually includes the earnings of some other member 
of the family. Although boys and girls do not usually hand 
over the whole of their earnings to their parents, they con- 
tribute something to the upkeep of the home; and a man 
whose wife or children are earning might only make his 
economic position worse by moving to a district where he 
could command a higher wage himself, but his wife or children 
could find no employment, or less remunerative employment. 
In spite of the tendency of modern industry to deal with the 
individual rather than with the family, the family is still an 
economic unit as well as a social unit for many purposes. 

Real Wages. — So far we have been considering the 
money income of the worker ; the real income of the worker, 
however, consists of the goods and services that the money 



Wages 283 

income will purchase, and the purchasing power of money 
varies from place to place, and from time to time. Allowance 
must be made for differences in the cost of living, a difficult 
and hazardous calculation to make, before we can compare 
wages in one country or district with wages in another, or 
wages at one time with wages at another. For instance, the 
high money wages of artisans in the United States are dis- 
counted by the high cost of living ; the rise in money wages in 
England since 1895 has been more than counterbalanced by 
the concurrent rise in prices. Whatever the cause of them, 
changes in the general level of prices do occur, wages usually 
do not rise as quickly or fall as quickly as prices, so that a 
great change in the economic condition of the wage-earning 
class may take place, of which the changes in money wages 
give no indication. 

So far we have been considering wages as an indication of 
the economic position of the worker. The weekly wage is 
only a rough indication of the true money income, and the 
money income may give a false impression of the real income. 
Other elements that can be subjected to no money measure 
enter into a comparison between different occupations ; social 
standing, opportum'ties of promotion, risk, independence, 
health, have all to be considered. " The attractiveness of a 
trade," in Dr. Marshall's words, " depends not on its money 
earning but on its Net Advantages." We have next to 
consider wages from the point of view of the employer. 

II 

Wages and Labor Cost 

Relation of Wages to Labor Cost. — How far do high wages 
mean high labor cost or value, how far are low wages " cheap 
labor"? Labor cost and wages are constantly identified. 
Protection is defended on the ground that it keeps prices up. 



284 Economics for the General Reader 

and high prices are needed to pay high wages. Labor leaders 
are told that higher wages will not benefit the workers because 
they will mean higher prices ; legislation to raise wages in 
" sweated " industries in England was opposed on the ground 
that " sweated " articles were bought chiefly by the very 
poor, and to raise the wages of the workers who made them 
would raise their prices and make it impossible for the poor 
to buy them. The fallacy in such arguments is easy to detect. 
The employer buys labor, not the laborer; if he can get a 
great deal of labor from one man, it may pay him as well as, 
and will probably pay him better than, buying a little labor 
from each of two or three men. High wages, if the amount or 
quality of labor given in return for them corresponds, mean 
" cheap labor " ; low wages, if the labor given in return is 
inefficient or small in quantity, mean " dear labor." The 
cheapest textiles in the world are made in Lancashire, where 
textile " real " wages are the highest in the world. Dr. 
Schulze-Gaevernitz sums up the conclusions of his investigation 
into the relation between wages and product in the cotton 
industry in the sentence, " Where the cost of labor {i.e. piece 
wages) is lowest the conditions of labor are most favorable, 
the working day is shortest and the weekly wage of the opera- 
tive highest." Mr. and Mrs. Webb point out that some of the 
most expensive West of England fabrics are made by the 
lowest wage labor in the English woolen industry; while 
some of the highest wages in the industry are earned by 
weavers of shoddy " tweeds " in the West Riding. 

Wages and Output. — Wages and the value of labor are 
two distinct things ; the value of labor, what it costs him, is 
the thing that matters to the employer, wages to the laborer. 
Wages may rise indefinitely without hurting the employer's 
interests, so long as his labor cost is not increased ; so long, 
that is, as he pays the higher wages only to workers who earn 
them by an equivalent output of labor, and can get as many 
workers of that quality as he needs. On the other hand an 



Wages 285 

employer may by improved organization reduce his labor 
cost (i.e. the value of labor) without disadvantage to the 
worker, if the result of the improved organization is to enable 
the worker to earn more, though at lower piece-rates ; there 
is a limit, however, to this possible advantage in the danger 
of undue " speeding up " or " overdriving." The opposi- 
tion between employer's interest and worker's interest is 
wrongly conceived, if it is thought of as simply a difiference 
about wages. It is to the employer's interest to beat down 
wages, only if the labor to be got from each worker is a fixed 
amount ; if an increase in wages will stimulate the worker to 
increased exertion and enable him to do better work, then it 
may pay the employer to raise wages, for by so doing he will be 
getting his labor as cheaply. Similarly, the worker can get 
the higher wages, which are his object, without increasing 
labor cost to his employer if he increases his efficiency; it is 
of course to his interest that the value of labor should be as 
high as possible, but wages can be increased by increasing 
the amount of labor given for them without any change in 
the value or cost of labor. A Lancasliire manager once came 
to manage a Yorkshire weaving estabhshment. Meeting an 
acquaintance soon afterwards he said : "I can't understand 
how you Yorkshire employers can get your labor for the wages 
you pay." After three months' experience of the " cheap " 
labor, he met the same acquaintance with a different tale : 
" I can't understand," he said, " how you Yorkshire manu- 
facturers can pay the wages you do for the labor you get." 

Ill 

Wages and Trade Unionism 

Inseparability of Worker and His Labor. — Labor is not a 
commodity, but it is bought and sold Hke a commodity. 
Society (until recently) has allowed its price to be settled 



286 Economics for the General Reader 

by the relations of supply and demand like the price of any 
commodity. Both the thing sold and the sellers of it, how- 
ever, have characteristics which distinguish labor from commod- 
ities. The seller of labor cannot control the quality of the 
supply. The laborer sells labor, he does not sell himself ; 
the quality of the labor he has to sell depends largely on his 
social environment, and especially on his parents. If he has 
been starved as a child in body and mind, his work as a man 
will suffer; if no foresight was exercised in his choice of an 
occupation, and he was put to the trade which gave the biggest 
immediate wage and no prospects of anything better, he will 
have no special skill to sell. The expenditure of money and 
trouble on training is necessary in youth, if the labor of the 
man is to be valuable ; the investment must be made by the 
parents, the return comes not to the parents but to the child. 
Hence many parents do not make the investment even when 
they could. For the same reason the supply of labor is 
adjusted to the demand only very slowly. The success with 
which it is done depends largely on the foresight of parents, 
and after all their pains some great technical invention may 
make their forecast wrong. Though he sells his labor and not 
himself the laborer must deliver it himself, " It matters 
nothing to the seller of bricks whether they are to be used in 
building a palace or a sewer ; but it matters a great deal to 
the seller of labor " (Marshall). There may be a great 
demand for a certain kind of labor in one district, while in 
another district men with that kind of labor to sell are un- 
employed, yet unable to leave the district because they own 
their own houses or have children working. 

Perishability of Labor, — Again, labor, like time, will not 
keep : it must be sold at once or it is lost forever ; it cannot be 
withheld from the market one day and saved till the demand is 
better. This characteristic of labor puts the seller of it in a 
weaker bargaining position than the buyer, and his position is 
usually the weaker without this aggravation. He has usually 



Wages 287 

no reserve, or only a small reserve, and has therefore less power 
to wait ; he withholds his labor only at the risk of starvation 
or the Poor House for himself and his family. He has usually 
an inferior knowledge of the market, of the prospects of trade 
and the demand even for his own labor ; is it likely that un- 
aided he can match his wits against a keen business man and 
meet with success? Again, he has only one unit of labor to 
sell, and is absolutely dependent on the sale of it ; the em- 
ployer may be purchasing hundreds of units, and can easily 
dispense with any individual unit without loss. Their 
general carelessness about money-getting makes it a priori 
unlikely that working men get all they could in wages. Un- 
like their antagonists, the employers, they are not engaged 
in a struggle to get rich ; like the scholar and the professional 
man, the ordinary working man is not interested in money- 
making. So long as he gets the wage to which he is accus- 
tomed, and gets it steadily, he is satisfied ; as a rule it is only 
when an attack is threatened on his customary standard, or 
rising prices invite an application for higher wages, that he 
fights with any energy. 

Purpose of Trade Union. — The trade union is an organiza- 
tion designed to put the seller of labor on an equality with the 
buyer as regards bargaining strength. The first great weak- 
ness of the operative acting singly is his lack of any reserve 
that will enable him to hold out for a fair price for his labor. 
By associating with other operatives and forming a common 
fund, he can put a " reserve price " on his labor; the union 
will maintain him while he is without work through refusing 
work at less than the standard rate. By contributing to the 
common fund he " insures against " exploitation. The 
second great weakness of the operative acting singly is that 
he sells labor retail, while the employer buys it wholesale. 
By associating with the other operatives in his trade, the 
seller is put on an equality with the buyer, or even given 
an advantage in this respect ; instead of having to deal with a 



288 Economics for the General Reader 

single impecunious laborer, the employer has to bargain with a 
trade union delegate controlling, if not all the labor in the 
trade, at any rate a sufficient proportion of it to inconvenience 
the employer who does not come to terms with him ; instead of 
risking the loss of a single laborer, the employer risks the 
loss of all or most of his laborers. And a trade union delegate 
or agent, appointed because an association for the purpose of 
collective bargaining must have officials, remedies the third 
great weakness of the operative, his ignorance of the market 
and lack of experience in salesmanship. Just as the business 
man, however experienced himself, employs the services of a 
specialized agent, the stock-broker, in selling his stock ex- 
change securities ; just as the man of property who wishes to 
sell property, if he is wise, employs the assistance of a broker ; 
so the operative in an organized trade sells his labor through 
an agent, leaving the agent to settle the price. In London, 
where standards of social organization are low, and in parts 
of America which seem to have no standards, employers 
object to their operatives using agents ; adopting the attitude 
of Pharaoh to Moses and Aaron, they insist on " dealing with 
the men direct." They assert a claim " to carry on their 
businesses in their own way," as if any business that controlled 
the fates of some hundreds of citizens and their families could 
be a purely private affair. In the trades in which trade 
unionism is strong, employers as well as operatives have 
found it a convenience to deal through agents. The standard 
rate and standard conditions, the collective bargain, and the 
expert agent, are the chief aims of trade unionism ; friendly 
society work, strikes, and even political work are only means 
to these ends. 



CHAPTER XVII 
V WAGES (Continued) 

I 

The Subsistence Theory of Wages 

Origin and History. — Three theories have had a wide 
currency as explanations of wages. The earHest is the Sub- 
sistence Theory, the so-called " Iron Law of Wages," the 
theory that wages constantly tend to fall to the amount just 
necessary to maintain the laborer and bring up the new 
generation. It is a cost of production theory. It arose in 
the eighteenth century, when observation of laborers, especially 
in France, showed them in possession of a bare subsistence. 
Any increase in their incomes was followed, it was thought, 
by an increase in the population, and the competition of the 
additional labor would bring the remimeration of the laborer 
down to subsistence level again ; if, on the other hand, the 
laborer received less than subsistence, he would starve or his 
children would, and the consequent shortage of laborers would 
force the value of their labor up again to subsistence point. 
To-day the theory is based on the behef that competition 
for work is so great that any subsidy to the laborer from the 
State or charity will merely induce him to accept a lower 
wage, leaving his income as it was. 

The theory is a gloomy doctrine and did much to earn 
for PoUtical Economy the nickname of the " Dismal Science " ; 
it is, however, a true account of the influences governing the 
u 289 



290 Economics for the General Reader 

remuneration of labor among unreflecting and custom-ridden 
people, who have never known more than a bare physical 
subsistence. The government of Egypt, since the English 
occupation, has doubled the wealth of Egypt, but the popu- 
lation has almost doubled also, and the individual fellaheen 
are therefore not very much better off; the great irrigation 
works of India have made individual peasant-farmers somewhat 
richer, but their chief effect has been to increase their number. 
The Report of the Royal Commission which recommended 
the reform of the English Poor Law in 1834 was based on this 
highly abstract theory and collected a large number of in- 
stances in which subsidies from the public treasury had de- 
pressed wages ; the Report, however, can hardly be taken as 
a reliable explanation of the condition of labor in 1834, since 
it ignored the enclosure of 7,000,000 acres of common, the 
destruction of the chief domestic industries, the rise of the 
early unregulated factories, the great war with its crushing 
burden of taxation, in a word, the Industrial Revolution ; and 
the evidence collected for the Royal Commission of 1905 
suggests the subsidies from the public treasury have little 
or no effect on wages to-day. 

Relative Character of Subsistence Theory. — The word 
" subsistence " in this theory can be given no very definite 
meaning. Such attempts as those of Mr. Seebohm Rowntree 
to state an income which would just supply a family with the 
bare necessities for physical efficiency give the term a mean- 
ing, which is definite and valuable, but something quite 
different from the meaning it must bear in this theory of 
wages ; for it is only since the middle of the nineteenth cen- 
tury that a majority of the workers of any country have 
enjoyed a subsistence income according to his definition, and 
outside English-speaking countries it may be doubted whether 
a majority of the workers in any country have it to-day. 
Even if that difficulty be overcome, the history of the working 
classes in the nineteenth century has refuted the theory. In 



Wages 291 

Western countries population does not respond to increases 
in wages in the way this theory requires. If anything, the 
reverse is the case ; as wages rise the birth-rate falls, and the 
lowest recorded birth-rates are in those states where the worker 
has exceptionally high wages, namely in Australia and among 
the native-born populations of Rhode Island and New 
Jersey. In the United Kingdom, although population grew 
steadily, real wages trebled in the last seventy years of the 
nineteenth century. The theory, however, in a confused and 
imrecognized form, influences political thinking still and 
accounts for a good deal of the opposition to social reform. 

II 

The Wages Fund Theory of Wages 

Basis. — The Subsistence Theory was succeeded as the 
" orthodox " explanation of wages by the so-called Wages 
Fund Theory. The production of most commodities under 
modern conditions takes a long time ; the laborer has to live 
while he is waiting for the product of his labor ; what he lives 
on while he is waiting is the accumulated stores of past 
production. In this sense wages are an advance from capital. 
Hence it was argued that " Wages depend mainly upon the 
demand and supply of labor ; or, as it is often expressed, on 
the proportion between population and capital " (Mill). 
As a consequence of the theory it followed that, so long as 
the proportion between population and capital remained un- 
changed, wages could rise in one industry only at the expense 
of another. The proof of this rested on three assumptions : 
first, that wages could be increased only at the expense of 
profits (so long as the proportion of population to capital 
remained unchanged) ; second, that any fall in profits, due 
to such a rise in wages, would drive capital out of an industry 
or a country, and so lessen the demand for the labor ; third, 



292 Economics for the General Reader 

that any rise in wages would attract new labor from other 
industries, which by its competition would force wages down 
again, or the rise in wages would lead to an increase in popu- 
lation, which would have the same effect in forcing wages 
down. None of these assumptions are borne out by the facts. 
The first confuses wages with labor cost; a rise in wages 
need diminish profits not at all, if accompanied by a corre- 
sponding rise in efficiency. The second attributes to capital 
a sensitiveness which it does not in practice exhibit ; capitalists 
expect some fluctuations in profits, and the causes of fluctua- 
tions are so numerous that concessions to employees have not 
the overwhelming importance attached to them in this theory. 
The third assumption attributes to working men an adapt- 
ability, a knowledge of the labor market, and a determination 
to find the most remunerative employment, which they do 
not exhibit. 

Difficulties of the Theory. — The difficulty of squaring with the 
facts the broad statement that wages depend on the proportion 
between population and capital led Mill first to amplify and 
qualify it, and afterwards to abandon it. " By population," 
he said, " is here meant the number only of the laboring 
class, or rather of those who work for hire ; and by capital, 
only circulating capital, and not even the whole of that, but 
the part which is expended in the direct purchase of labor." 
The inconvenient fact of fluctuations in wages he could 
then explain by arguing that in times of depression some 
of the capital available for wages was withdrawn from use, 
and this inconvenient " capital which the owner does not 
employ in purchasing labor " "is the same thing to the 
laborers, for the time being, as if it did not exist " — for all 
the world like the wasted labor which Marx could not fit 
into his Labor Theory of Value, and which he said, therefore, 
" does not count." Only the capital actually spent on wages 
" counts " in this theory; " nothing," Mill says, " can per- 
manently alter general wages, except an increase or a diminu- 



Wages 293 

tion of capital itself (always meaning by the term, the funds 
of all sorts, destined for the payment of labor)," compared 
with the " quantity of labor offering itself to be hired." 
Similarly nothing can permanently alter the general, which 
presumably means the average, price of turnips except an 
increase or a diminution of the funds of all sorts destined for 
the purchase of turnips, compared with the quantity of turnips 
offered for sale. All the theory amounts to in this exact 
form is that the amount received in wages depends on the 
amount spent in wages. 

Present-day Significance. — The importance of the theory 
lies in its consequences, which, like those of the Subsistence 
Theory, still influence opinion, although the theory itself is 
dead. The exact statement of the theory has obviously no 
important consequences, but is easy to prove ; the loose state- 
ment, that wages depend on capital, cannot be proved, but has 
extremely important consequences. Now the proof of 
the unimportant exact statement gave authority to the 
important inferences to be drawn from the unproved general 
statement. If wages were fixed by the proportion between 
population and capital, trade unionism was futile and wicked ; 
it could raise the wages of one section of workers only at the 
expense of the wages of other sections ; wages generally 
could only be raised in two ways, by increasing capital or 
checking population. This theory is the explanation there- 
fore of the belief, common in the middle class, that Political 
Economy has proved trade unionism to be futile. 

Ill 

Productivity Theories of Wages 

Basis. — The weaknesses of the Wages Fund Theory 
directed attention to the influence which the efficiency or 
productivity of the worker exercises on wages, and recent 



294 Economics for the General Reader 

theories base themselves on this influence. We have already 
had occasion to notice that high wages do not necessarily- 
mean high labor cost. This fact Ues at the basis of the 
productivity theory of wages. A worker who is efl&cient at 
his work will get high wages, because the product of his work 
will be great; anything that increases the efiiciency of the 
worker will, by making him more productive, tend to increase 
his wages. The chief contemporary explanation of wages is 
that competition secures for the laborer just what he pro- 
duces ; " Wages," in Hadley's words, " . . . are the dis- 
counted product of industry," i.e. the value of the product 
less the interest on the wages from the time when they are 
paid to the time when the employer receives the price of the 
product. 

Wages as a Market Price. — This conclusion is reached 
(or supported) by an analysis of the action of the employer 
who, as we saw, is the organizer of production. The different 
employers producing any commodity compete in the sale of it ; 
the price at which it is sold is a market price, settled by the 
general relations of the supply of the commodity and the 
demand for it, and therefore fixed or " given " for any in- 
dividual employer. The endeavor to secure the productive 
economies of a large output leads employers to let their prod- 
ucts go at any price that covers cost of production and leaves 
some profit, and an employer who fails to adopt the most 
suitable methods and appliances for keeping cost of production 
down is beaten out of the trade. The price, then, which he 
gets for his product is fixed for the employer, not usually 
by him ; even if there are only a few employers or only one 
employer in the trade, the possibility of others entering 
the trade and the desire to sell a large output will keep prices 
down. Similarly competition between employers for land, 
labor, and capital, will keep the prices of these agents of pro- 
duction up. For any individual employer the price he has 
to pay for any kind of labor is fixed by the power which 



Wages 295 

the laborer has of taking his labor to some other employer, if 
his present employer will not give him the market price for it ; 
the price that any trade has to pay for its labor is fixed by the 
certainty that labor will be diverted from the trade, if other 
trades offer better wages lor the same degree of skill and 
exertion. Wages are usually the last thing that an employer, 
cutting down expenses, attacks ; partly because bargaining 
about wages, except in well-organized grades, may mean 
as many bargains as there are individual operatives, partly 
because discontented and hostOe operatives give bad labor. 
Hence for the individual employer rates of wages, just like the 
rate of interest and the rent of land, may be taken as fixed. 

Basis of Profits. — If, then, prices are fixed for him, and 
the rates he has to pay for his agents of production are fixed 
for him, what control can an employer exercise over his 
profits? For his profits are merely the difference between 
what he pays for the '* agents of production " and what he 
receives for the product. There is one way in which he 
can increase his profits under these conditions, namely, by 
securing a more economical combination of the agents of 
production than his competitors. Paying the same rates of 
wages for labor, the same rate of interest for capital, the 
same rent for equally advantageous land as his competitors, 
he can still, by superior organization, produce cheaper than 
they can, and, since he gets the same price as they, secure 
larger profits. He may employ his capital in more effective 
forms, he may substitute machinery in a process usually 
performed by hand, he may plan his factory differently, 
he may combine the different grades of labor in different 
proportions, he may combine his materials differently or 
experiment with new materials ; even in the most elaborate 
and scientific industry there is always room for improvement 
and therefore for the ingenuity of the organizer. 

Organization of the Agents of Production. — Hence em- 
ployers are constantly comparing different kinds of labor, 



296 Economics for the General Reader 

labor and capital, capital and land or its products. They 
buy each simply according to its productivity. If by using 
more capital and less land or labor they can increase their 
product for a given expenditure, they will use more capital, 
and to get this additional capital will, if necessary, offer a 
higher price for it ; i.e. the rate of interest goes up because an 
addition to capital will increase production more than an 
addition to labor or land. If by employing more labor and, in 
proportion, less capital and land they can increase their 
product for a given expenditure, they will employ more labor, 
and to get it will, if necessary, offer higher wages ; i.e. wages 
go up because the productivity of labor has increased. In the 
same way the value of land is determined by its productivity 
to the user of it. Different kinds of labor are compared with 
each other in the same way, the employer using more fore- 
men or more general laborers or more machine-tenders, 
according as each will increase his production. Conversely, 
if labor is cheap, relatively to capital and land, the employer 
will use more of it ; if capital becomes cheap he will increase 
his use of capital; if land is cheap he will use more land. 
Land, labor, and capital compete through the employer for 
employment and payment ; he distributes his resources 
among them solely in proportion to their productivity; i.e. 
their value depends on their productivity to the organizers of 
production. There is a struggle among the different possible 
agents of production for the survival of the fittest, the 
" fittest " being the most productive ; the " selection " of 
the fittest is done by the employer in the act of organizing 
production. Some writers speak of the employer in this 
connection with the awe one would observe towards some 
stupendous natural force, and term this comparison of the 
agents of production the " Law of Substitution," 

Application of the Marginal Concept, — The analysis is 
carried one step further : land, labor, and capital are always 
employed together, no productive process can be carried on 



Wages 297 

without the cooperation of all three. The question, there- 
fore, before the employer is never, " Shall he employ any 
labor or any capital or any land at all," but always, " Shall 
he employ more land and less labor and capital, or more labor 
and less land and capital, or more capital and less labor and 
land ? " He considers the productivity not of land as a whole, 
labor as a whole, or capital as a whole, but of a httle more 
or less of each ; hence economists (with that fondness for the 
word " marginal " which does so much to confuse the reader 
of a modern economic treatise) speak not of " Productivity " 
but of " Marginal Productivity," and say that the values of 
land, labor, and capital all depend on their " Marginal Pro- 
ductivity." 

Relation of Supply to Marginal F*roductivity. — This 
refinement of the theory — like the Marginal Utility Theory 
of Value — is important because it brings out the relation of 
supply and demand in determining the value of an agent of 
production. When labor is plentiful, relatively to capital 
and land, as in Eastern countries, it will be employed in 
work which in richer countries is done by capital in the form 
of power-machines, and its work will be comparatively un- 
productive because it lacks tools, machines, and other capital 
appliances ; therefore its wages will be low. In a new country, 
where land is plentiful and labor relatively scarce, labor will 
be employed only where its productivity is high, capital will 
be imported to supply it with the best implements and aids ; 
therefore wages will be high and rents low. The productivity 
of an agent of production depends on the amount of its supply 
relatively to the supply of the other agents with which it co- 
operates ; more of it, by lowering its productivity, will send its 
value down, less of it, by raising its productivity, will send its 
value up. Conversely a change in the organization of produc- 
tion which increases its productivity will increase the demand for 
it and raise its value, a change that lowers its relative produc- 
tivity will decrease the demand for it and send its value down. 



298 Economics for the General Reader 

Criticism. — This theory seems to rely too much on the 
effectiveness of competition. It assumes too much in assum- 
ing, as it does, that employers will pay what they can pay. 
They can pay the worker the value of what the worker con- 
tributes to production ; they need not do so unless the com- 
petition among employers for labor is at least as strong as the 
competition among workers for employment. Now although 
there are usually employers wanting labor as well as workers 
wanting employment, there are usually more workers wanting 
employment than workers wanted by employers. The ex- 
ponents of the theory argue that the competition among em- 
ployers must be the keener for three reasons : they have build- 
ings and plant which earn them nothing if they cannot get 
labor ; they have a " connection " in their market which they 
run the risk of losing by any stoppage ; and they are always 
anxious to increase their output in order to avail themselves 
of the decreased cost of production which is usually possible 
with a larger output ; to these may be added the even more 
important consideration that the employer can make profits by 
successful anticipation of the needs of the consumer as well as 
by capable organizing work, without paying the laborer any 
less than the discounted value of his product. Against these 
considerations must be set the fact that the laborer risks 
more than the employer if they cannot come to terms; the 
employer risks loss of profits, the laborer risks starvation and 
the starvation of his wife and children, or alternatively, the 
degradation of the Poor House ; if the employer risks having 
his plant standing idle, the laborer risks having to break up 
his home, leave the town he is attached to, and seek employ- 
ment in a new district. On both sides the risk of loss is so 
great that the parties usually come to terms with surprisingly 
few disputes; and the connection between any individual 
employer and any individual workman is in most trades one 
which can be broken only with loss to both, since a work- 
man who has been some time in a shop is worth more to his 



Wages 299 

employer than a new man would be or than he would be in 
another shop. 

Although the employer can make profits while giving 
full productivity value for labor, it is a characteristic of 
business that a man takes what he can get, and an employer 
would be merely unbusiness-like who did not take advan- 
tage of the laborer's weakness as a bargainer; fortunately 
some business men are unbusiness-like. Moreover the 
" productivity " of the laborer depends, more than on any- 
thing else, on the employer's powers of organization. Slack 
organization on the part of the employers in a district will 
make the labor of the district less productive than labor 
of the same skill and the same intensity in districts where 
employers do their organizing work better. To say in such 
a case that wages are low because the productivity of labor 
is low may be true, but it is to suggest that the workman is to 
blame when really the employer is at fault. Where this is the 
case, the workers, by insisting on higher wages, may increase 
their productivity without in the least increasing their labors ; 
for the productivity of a given amount of labor will be in- 
creased when the employer abolishes waste, removes disorgani- 
zation, and supplies his workers with the best appliances. 

Productivity and Market Value. — The word "productivity" 
requires examination. The word usually means " output " 
measured by the yard, ton, or bushel. But when we say that 
wages depend on the productivity of labor, productivity is 
not equivalent to " output " ; it means merely " productivity 
of market-value," which may correspond with output, but 
also may not. If a king dies suddenly, there is a sudden 
increase in the value of mourning goods ; the labor, of which 
these goods are a product, has become more " productive," 
although the skill and exertions of the laborer, and the number 
of yards of cloth he turns out, are precisely the same as they 
were before. This distinction is often forgotten, and the 
productivity theory of distribution comes to be used (un- 



3CX3 Economics for the General Reader 

consciously perhaps) as a justification of the present unequal 
distribution of the national income. Each, it seems to show, 
gets what he produces ; what could be fairer ? It is forgotten 
that the market-value by which this productivity is measured 
bears no constant relation to social service. The theory is 
true (if at all) only if we give " productivity " its second 
meaning, " productivity of value," the theory justifies the 
present distribution (if at all) only if it has its first meaning, 
" output." In the only sense of the word " productivity " 
in which the productivity theory of distribution is true, the 
man who receives $25 a week for looking after Pekinese 
puppies for an American heiress is four times as " productive " 
as the farm-laborer receiving $25 a month ; the services of the 
two to society do not bear the same relation. 

Substitute Terms for Productivity. — To avoid the am- 
biguity of the word " productivity," the commoner word 
" efficiency " is sometimes substituted, and wages are said to 
depend on efficiency. But the new word is not free from 
ambiguity itself; efficiency will help to explain differences 
in wages in the same occupation, since such differences will be 
reflected in output, but it will not explain differences in wages 
in different occupations. We have no common measure of 
efficiency in different occupations except the wages paid, so 
that to use efficiency to explain the wages is to beg the question. 
The low-wage worker may be just as efficient at his work as 
the high-wage worker at his, and the low-wage work may be 
equally indispensable to society; while it may be true that 
the low-wage worker could not do the high-wage worker's 
work, it may be equally true that the high-wage worker could 
not do the low-wage work ; a joiner could not (without a fresh 
industrial training) tend a spinning mule, but neither could 
a spinner (without a fresh industrial training) frame a roof. 
Yet another principle of wages has been offered in " Economic 
Worth." ^ Economic Worth, however, turns out on ex- 
^ Smart, Distribution of Income, p. 322. 



Wages 301 

animation to be merely a misleading synonym for productivity 
of market value — misleading because the plain man always 
associates with the word " worth " the idea of moral desert, 
so that the statement that distribution is in accordance with 
" economic worth " inevitably carries with it the suggestion 
that the poor are poor because they are bad and the rich 
are rich because they are good. 

IV 

The Influence on Wages of the Standard of Life 

Complicated Character of Wage P>roblem. — The theories 
which we have been considering are really attempts to answer 
different questions about wages. The different theories are 
not necessarily inconsistent; each may contain and express 
one important influence on wages, while neglecting other 
influences. There are three problems of practical importance 
involved in the apparently simple question, What fixes wages ? 

(i) What fixes the share that goes to labor of the joint 
product of labor, land, and capital? 

(2) How is it that wages in a country like England are 
usually higher than wages on the Continent, and usually 
lower than wages in the United States? 

(3) Why do wages vary in different occupations ? and what 
fixes the relation between wages in different occupations? 

Subsistence and the Standard of Living. — The Subsistence 
Theory, while professing to be a complete explanation of 
wages, was directed primarily to answering the first question ; 
for the first question was the question of most interest in an 
age when laborers were everywhere poor, although most 
things were made by manual labor with little aid from capital. 
It found the explanation of low wages in the competition of 
the laborers for employment, which kept wages down to a • 
bare subsistence. The theory emphasizes the importance of 



302 Economics for the General Reader 

the influence — competition for employment — which makes 
labor, although it is indispensable, be content with only a 
share, and not a very large share, of the joint product. The 
theory, however, fails to give a satisfactory explanation of 
wages, because it assumes unlimited competition among 
laborers for employment. So far as limits are placed on 
competition among laborers, wages can be kept above bare 
subsistence level. Now limits are placed on competition. 
The object of trade unionism is to place a limit on competition 
for employment ; a trade union is an association of workers 
with a particular kind of labor to dispose of who agree not to 
accept wages below a certain rate, and if necessary to prefer 
unemployment. But apart from the overt action of trade 
unions, competition is very seldom without limits ; there is in 
nearly all occupations a tacit and informal agreement among 
the workers to observe a certain standard of life and to refuse 
any wage which will not support that standard. If we sub- 
stitute " standard of life " for " subsistence " in the theory, 
it will throw a great deal of light on wages. The Subsistence 
Theory made the mistake that Mill made of identifying the 
" supply of labor " with the population ; the two are distinct, 
because the population consists of human beings with wills of 
their own, who can vary the amount of labor they can and will 
give. Unless the wage offered will cover the standard of life 
of the worker, he will usually refuse to supply any labor at 
all, confident that no one else who can do the work will take 
it at a less rate than himself. Wages then cannot usually fall 
below the standard ; they will not rise much above it, partly 
because competition among employers will deter them 
from offering more, partly because the ordinary workman, 
once he has got his standard of life secured, has little further 
interest in money-getting and will not press for more. 

Nature of Labor " Supply." — In considering the meaning 
of the word " supply " in Chapter XIV we found it necessary 
to distinguish between two uses of the word : (i) the amount 



Wages 303 

of a commodity that exists, or can be produced within a given 
time ; (2) the amount of the commodity that is or will be 
offered for sale. Whether the two amounts coincide or not 
depends, we saw, on the control of the commodity. Where 
free competition in selling obtains, they will coincide ; where 
there is some restriction on competition, they need not coin- 
cide. In the same way the " supply of labor " may mean 
either of two things: (i) the entire energies of the entire 
population; (2) the amount of work that the population is 
induced to perform. It is the supply of labor in the second 
sense that influences wages, just as it is the " supply " of a 
cormnodity in the second sense of that word that influences 
value. And in the case of labor the existence of tacit or 
explicit agreement to restrict competition in selling makes it 
unlikely that the " supply of labor " in the second sense will 
ever be exactly the same thing as the " supply of labor " in 
the first sense. 

Relative Character of Standard of Living. — The Standard 
of Life is a conception that is seldom defined, yet is not in- 
definite ; it is difficult to express in dollars and cents, yet it is 
held with sufficient clearness to influence action. The con- 
ception becomes more comprehensible if we speak of standards 
rather than the standard, because a workman's conception of 
the wage to which he thinks himself entitled is influenced by 
several standards. There is the " grade " standard ; the 
man with a trade considers that he is entitled to a living about 
50 per cent better than that of his laborer. There is the 
trade standard ; the relation of spinners' to weavers' wages 
in any given district and branch of the textile trades is well 
understood, and a change in one would probably lead to a 
demand for a change in the other. There is the district 
standard ; the Fall River textile operative expects and gets 
a higher wage than the South Carolina textile operative, the 
New York City than the country carpenter; and, similarly, 
countries have different standards, after all due allowance 



304 Economics for the General Reader 

has been made for differences in the cost of living. There 
are many standards, and the principles on which they vary 
are many ; but the conception of a standard of hf e is definite 
enough and influential everywhere.^ 

Influence of Conception of a Standard. — Certain modern 
methods of remuneration, economical to the employer but 
justly suspect with the operative, are based on the influence of 
this conception of a standard. The premium bonus system is 
the type of them. A piece of work will be timed ; since the 
worker cannot be expected to work at full strain all the day, 
a proportion, usually a third, will be added to this time, and the 

^ The. head of an English firm of millmg-machinery makers recently dis- 
covered that there were among the firm's employees a number of laborers 
receiving a wage of only iSs. (about $4.50) a week. The settlement of wages 
being a department of the firm's business he delegated to a subordinate, he had 
been ignorant of this, and at once had the wages raised to a guinea (about 
$5.25) a week. (Apparently he was ignorant of the "law" that competition 
forces the entrepreneur to hand over to the laborer the exact equivalent of his 
productivity.) The immediate result was that a class of machinists, whom he 
considered quite well paid at the wage they were receiving, about 275. ($6.75) 
a week, demanded a corresponding advance. The relation of the two standards 
was so clear to them, that they conceived that they had a right to the advance. 
Laborers with a recognized industrial status usually receive about two thirds 
the wage of the tradesmen with whom they work. The influence of the con- 
ception is Ulustrated by the comparative uniformity of earnings where wages 
are on a piece-rate basis. Variations occur, but they are not sufficient to 
destroy the conception of a standard; rather, the workers adjust their pro- 
ductivity to the standard. For the same reason, as has often been noticed, 
piece-workers' hours of work can be reduced gradually without any reduction 
of output ; the workers aim at a standard wage, and do enough work, whatever 
the time at their disposal, to earn it. If there were no such standard, such a 
question as "What wage does a FaU River spinner earn?" would be meaning- 
less; we could only ask "At what rate is he paid?" In occupations where a 
standard time wage is paid, there are differences of efficiency and industry 
among workers receiving the same wage; employers, however, tolerate them, 
because the more efficient compensate for the less efficient, and an exact adjust- 
ment of wages to output would usually not repay them for the trouble involved, 
while the operatives tolerate them because they are dominated by this con- 
ception of the standard, to which the less efficient as well as the more efficient 
are entitled. The manual workers as a class believe that if a man will not work 
neither shall he eat ; but they have never subscribed to the economic doctrine 
that a man should eat in proportion to his work. 



Wages 305 

resulting time is taken as the standard time in which the piece 
of work ought to be done. Then the worker is encouraged to 
get more use out of his employer's plant by being promised a 
reward if he does the piece of work in less than the standard 
time. He is not given, however, the full saving effected by 
his diligence ; the employer does not find it necessary to give 
him the full equivalent of his additional output ; it is usually 
divided equally between employer and operative. If the 
operative saves an hour on the standard time, he will be given 
an additional half-hour's pay; if, for example, he gets four 
hours' work (according to the agreed standard) done in three 
hours' actual time, he is paid for three and a half, not for four 
hours' work ; i.e. the employer gets the extra hour's work out 
of him for an extra half-hour's payment, in addition to extra 
earnings by his plant due to the greater use of it. Why is this 
possible? How is it that workers who would strike against 
a reduction of 25 cents a week on their standard wage will 
cheerfully give 10 per cent more work for 5 per cent more 
payment ? This reason would seem to be that their demand is 
governed by their conception of a standard wage. Regarding, 
say, $15 a week as their due, because $15 is the standard of 
the trade, grade, and district, they will fight strenuously for 
$15, and will usually prefer unemployment to accepting a 
lower wage ; but once they have got their standard, anything 
above that is so much " in their pocket," and they will not 
higgle about the price of the extra labor. Employers, recog- 
nizing this, usually induce men to accept the premium bonus 
system by guaranteeing the standard wage or something 
above the trade union standard. It should be noticed that 
encroachment on the workman's leisure is a different thing; 
if the employer asks him to exceed his standard time, the 
employer has to pay time and a quarter or time and a half 
for the excess ; but apparently he can induce the worker to 
exceed his standard output by paying him half-time rates for 
the excess. 



3o6 Economics for the General Reader 

To the influence of the same conception of a standard may 
be put down the carelessness about spending any excess of 
the standard wage, which has been more frequently noticed 
than the corresponding carelessness about money-getting in 
excess of the standard. We are told that laborers accustomed 
to $12 a week, if their wages are raised, will spend the addi- 
tional income in riotous Hving. Certainly any windfall, 
whether it take the form of a legacy, a compensation payment 
or a sudden increase in wages, is spent with less economy 
than the standard wage; the expenditure of the workman's 
standard wage is probably — in spite of middle-class critics 
who have never tried to live on $12 a week — the most 
economical spending done in the community, but anything 
above the normal will be spent with less care, just as in the 
middle class sudden wealth usually leads to extravagance. 
Cases do occur where the influence of this conception takes 
another form, and the laborer prefers to work less at the new 
rate, so that his actual income remains unchanged ; this will 
only happen when the standard of life is very low, as it is, for 
example, among casual dock laborers. There are occupations 
in which no standard does exist, the so-called " sweated 
trades " ; in them the workers' spirits have been broken ; 
they are incapable of the tacit combination needed to maintain 
a standard, and they can offer no resistance to any encroach- 
ment on their Hvelihood. The Subsistence Theory is a true 
explanation of their wages ; and since they are unable to set 
up and protect a standard for themselves, it is essential, to 
prevent social degeneration, that the State step in and impose 
a standard from outside. 

In most cases, however, a standard exists ; it is not a per^ 
manently fixed thing, but relatively to other economic in- 
fluences it is fixed, and it imposes an effective restriction on 
competition. The trade union, when it exists, is primarily 
an organization for protecting this standard, and, as oppor- 
tunity occurs, forcing it up. The other two theories of wages 



Wages 307 

Ignore this important fact of social psychology, although they 
may be not inconsistent with it. They assume that the worker 
will always insist on getting the absolute maximum that he 
can get, i.e. that he is actuated in his economic relations by 
purely commercial motives. He is not ; although com- 
mercialism is invading his moral ideas, percolating downwards 
from the commercial class, his principle is much nearer to that 
which Ruskin preached, " Unto this last even as unto thee." 

Permanence of Conception of Standard. — This conception 
of the standard of life, though fluctuating, is a relatively 
fixed thing in the flux of forces which determine distribution. 
The workman by combination, tacit or explicit, fixes it, and 
his employer adjusts production to it. The employer will 
do all in his power, usually with success, to secure an increase 
in output in return for every increase in wages, and, where the 
local standard compels him to pay higher wages than his 
competitors in other districts, to extract an amount of work 
correspondingly greater. Hence the theory that wages are 
fixed by the worker's standard of Hfe is not inconsistent with 
the theory that wages correspond with the worker's efficiency ; 
the worker fixes the standard, and the employer sees to it that 
his efficiency corresponds. It is not suggested, of course, that 
the worker can raise his wages by the simple process of spend- 
ing more; the conception of the standard of life influences 
wages only by producing concerted action or tacit combination 
among the workers who supply a certain kind of labor. For 
this reason it is usually more influential in stiffening their 
backs against a reduction in wages than in accelerating an 
advance. Anything that leads the workers to act together 
increases their control over wages; this conception of the 
standard of life leads them to act together, almost automat- 
ically, whenever real wages are threatened. It corresponds 
in industrial warfare to the trenches with which a modern 
army secures its fine ; it is a defense against attack, and a 
means by which any new advance may be made secure. 



3o8 Economics for the General Reader 

V 
The Influence on Wages oj the Volume of the National Dividend 

The Wages Fund Theory was directed primarily to 
answering the second question, how is it that wages are 
usually higher in England than on the Continent. It calls 
attention to the very important fact, that quite apart from 
the distribution of a country's wealth between land, labor, 
and capital, the amounts which all three receive are in- 
fluenced by the amount of that wealth. If we can assume 
that the distribution between the three factors proceeds 
on much the same principles in different countries, then the 
different levels of wages in different countries must be due 
to differences in the amount of the fund or flow of wealth 
to be distributed. 

Effect of Rising Wages on Other Shares. — The supporters 
of the Wages Fund Theory made the mistake (natural enough 
at the time) of assuming that capital was the only important 
influence on that fund or flow. A wider observation of facts 
has shown that the amount of a country's wealth — the 
" National Dividend," as Dr. Marshall calls it — depends not 
solely on the amount of capital employed, but also on the 
quahty of the labor and the nature and amount of the natural 
resources of the country. Workers enjoying a high standard 
of life and well trained industrially increase the National 
Dividend as much as an increase in capital will increase it, 
and may increase wages without trenching on the profits of 
capital; similarly wages can be high without trenching on 
profits, where a few million people have at their disposal 
the resources of a continent, as they have in Austrah'a. If 
the natural resources of a country, or its accumulated capital, 
or the science and skill of its inhabitants are great relatively 
to the number of its inhabitants, wages will be high; if 
population is dense, and there is Httle accumulation of capital 



Wages 309 

(as in India), or there are no exceptional natural resources (as 
in Belgium) to swell the National Dividend, wages will be 
low. Mill was quite right in arguing that any action of the 
worker that checked the accumulation of capital would tend to 
check the growth of wages, since it would check the National 
Dividend, on which wages as well as profits and rent depend ; 
he was wrong in assuming that a rise in wages must check the 
accumulation of capital, and that the accumulation of capital 
was the only important method of increasing the National 
Dividend. 

VI 

The Influence on Wages of Inequality of Opportunity 

Variation in Supply of Different Kinds of Labor. — The 

Marginal Productivity Theory seeks to answer all three ques- 
tions at once. The first question it answers adequately by 
saying that the share of the National Dividend going to 
labor depends on the productivity of labor relative to the 
producti\'ity of capital and natural resources, and this 
depends on its relative plenty or scarcity. The second 
problem it solves by referring to the different levels of pro- 
ductivity in different countries or districts, which correspond 
with the different wage levels. American and English cotton 
operatives have high wages compared with the cotton opera- 
tives of India, because they produce cotton goods of more value 
in a given time ; agricultural laborers in the North earn higher 
wages than agricultural laborers in the South, because they 
do more work or better work. These two questions it 
answers ; it is not much help with the third problem, the 
problem why different kinds of labor have different values. 
Its explanation is that wages depend on the relation between 
the demand for a kind of labor and the number of people who 
can offer it. Each worker's wages depend on the " pro- 
ductivity " of his labor, and the " productivity " of that labor 



3IO Economics for the General Reader 

compared with other kinds of labor depends on the number 
of people offering that kind of labor. This explanation, 
however, only states the problem, it does not solve it. The 
important question is, how is it that, relatively to the demand 
in each case, a large number of people can offer certain kinds 
of labor, while only a small number can offer other kinds. The 
question is the same as the question, why different standards 
of life exist together. What is the explanation of the fact 
that lawyers are few, so that their marginal productivity and 
therefore their earnings are high, while plowmen are numer- 
ous, so that their marginal productivity and therefore their 
wages are low? The plowmen could not do the lawyer's 
work, it is true, but neither could the lawyers plow. Sim- 
ilarly in the case of manual occupations : why are longshore- 
men many and machinists few ? 

Importance of Training. — The answer cannot be reached 
by any analysis of existing conditions ; a full explanation 
could only be found by an exhaustive historical inquiry into 
the occupations under comparison. Analysis will serve 
merely to indicate some important influences. The difficulty 
of the work is the explanation in some cases ; if a high degree 
of intelligence is required to do the work at all, the number of 
people who can do it will be limited. This explanation will not 
carry us very far. All the operations needed to supply all the 
ordinary needs of Hfe have been studied and simplified, until 
any person of ordinary intelligence, provided he have had the 
necessary training, can do most of them. Incomes derived 
from work vary far more than do native ability and capacity. 
The opportunity of training and entry into trades is then the 
important influence and the fundamental reason for the differ- 
ence in the wages of different occupations. Low-paid occu- 
pations are low-paid because they are overcrowded, while a 
high remuneration is secured for an occupation by restricting 
entrance to it. 

The restrictions take many forms. In the case of the 



Wages 3n 

learned professions the restriction takes the form of an expen- 
sive education ; by their monopoly of higher education the 
middle and upper classes retain a monopoly of the professions 
— with the scholarship system as a fairly efficient safety- 
valve for the discontent of the excluded masses. This 
monopoly is further buttressed by possible fees required on 
entrance to such professions as the law, which handicap 
clerks and others who might secure the necessary education. 
Similarly, the higher branches of the pubHc service are re- 
served for the same classes by the nature of the examination 
where appointment is by examination, by ** influence " and 
class prejudice where appointment is direct. Even in in- 
dustry and commerce class prejudice may close the road to the 
more important posts to all save exceptional workingmen. 
Especially in a country Hke England, although less so in the 
United States, large employers favor subordinates of their 
own social class, so that the workingman gets few chances of 
training himself for posts of direction ; the middle-class boy on 
entering a trade is given an all-round training, the working- 
class boy is specialized to one subsection by the age of 
sixteen. In the case of manual work, the need of special 
skill for the better-paid occupations excludes from them 
the many people who have the capacity but have never 
had the opportunity to acquire that skill. In some cases the 
apprenticeship system, in a few trade union organizations, 
restrict opportunity to enter a trade, in the same way as 
educational requirements limit entrance to the professions ; 
but here again the important influence is the expense of 
training. With equality of opportunity work and earnings 
might tend to correspond with native capacity ; as it is, the 
distribution among occupations of the nation's capacity is 
almost purely accidental. 



312 Economics for the General Reader 

VII 

Summary 

If now we return to the question which formed our starting- 
point — how society came to put a value of just $7.50 on the 
work of a certain workman — we shall be unable to answer 
it by reference to any single principle. 

We shall note first that a clear distinction must be drawn 
between wages and the value of labor, or, as it is more usually 
called, labor cost. Other things being equal, the more labor 
a man's energy, ability, training, and social circumstances 
enable him to give, the higher the wage he will be able to 
command; the less labor he gives, the lower his wages will 
tend to be. Hence there may be great variation in the wages 
of similar workers from place to place and from time to time 
without any variation in the value of labor, and consequently 
without any change in cost of production to employers and 
in prices to consumer. 

But the value of labor also varies from place to place, from 
time to time, and from occupation to occupation; this 
variation is independent of differences in the amount of 
labor given by different workers, and it needs explanation. 
Any theory, however, that attempted to comprehend all the 
influences on the value of labor in a single formula would 
be so abstract as to be useless. Moreover, some wages are 
capable of no rational explanation. In the " sweating trades " 
there are numerous cases in which different rates of wages 
are being paid for exactly the same work, and similar variations 
are to be found in all unorganized trades. All we can do — 
all any theory of wages can do — is to enumerate influences 
and indicate their relation and importance. Our survey of 
past theories suggests that there are three important influences 
in the long run: the volume of the flow of wealth in the 
country of the worker ; the relative plenty or scarcity of the 



Wages 313 

different agents of production ; the relative plenty or scar- 
city of different kinds of labor. While these are the chief 
determining influences in the long run, the chief immediate 
influence is the worker's conception of the standard of life 
to which he is entitled — by tacit agreement with his fellow- 
workers he will usually refuse to work at all for a wage in- 
sufficient to maintain this standard, and the consumers will be 
forced to pay his employer a price for the product of the work 
sufficient to enable the employer to pay him that wage. 



CHAPTER XVIII 

INTEREST AND PROFITS 

I 

The Distinction between Profits and Interest 

Necessity for Distinction. — The words " Interest " and 
" Profits " are often used indifferently for the same thing ; if 
we wish to avoid confusion we must distinguish between 
them. Profits are the share in the flow of wealth which goes 
to the owners of businesses, and are calculated by deducting 
the expenses from the receipts of businesses ; interest is the 
share that goes to the owners of capital. Profits usually in- 
clude interest, since the owners of businesses usually supply 
some, if not all, the capital used in them ; they include, how- 
ever, several 'other important elements. 

Wages of Management. — First, profits usually include 
some pajrment for the work of organization, which we studied 
in Chapter III. The owner of a private business works, he 
gets his wages in the form of profits. He gathers together 
a number of specialized workers, provides them with the 
necessary machines and equipment, finds material to work 
on, and turns these isolated individuals and machines into 
a productive organization. The business started has to be 
run, the organization has to be managed, just as a machine 
has to be tended, and the owner-manager has to be paid by 
society Uke any other machine-tender. In a majority of 
cases he draws his payment for management in the form 

314 



Interest and Profits 315 

of profits. As we saw, starting a business needs a different 
and a higher order of ability than running one, and the biggest 
profits are probably made by the starting of businesses, by 
discovering a new or unsatisfied want and organizing the 
means of satisfying it. The payment for this work may be 
drawn, not in annual payments, but in a lump sum, the 
creator of the business selling it to the public in the form of a 
corporation, and receiving for it, not what it cost him to build 
up, but the capitalized value of its earning capacity. 

Profits and Risk-taking. — The second important element 
in profits is payment for undertaking risks, especially the 
risks involved in anticipating demand and supply. It was 
shown in Chapter IV that risks are unavoidable in a society 
that avails itself of the economies of the division of labor. 
The division of labor involves production in anticipation of 
demand, and fluctuations in the volume of the supply of raw 
material are constantly changing the value of a commodity 
between the commencement of the process of production and 
its completion. Further, it is impossible to anticipate cor- 
rectly in every case what the demand will be ; whenever a 
mistake is made in this anticipation, whenever the public 
want less of one thing and more of another, or something 
different from what has been made, there is a loss. The 
thing made does not fetch the price anticipated, and the 
owners of the business that made it bear the loss. They 
can bear this loss, because at other times they have made 
just what turned out to be wanted and got a good price 
for it. Profits are big when the managers of businesses 
anticipate correctly what the public want and will pay for, 
losses are incurred when their anticipations are incorrect ; 
in the long run the profits must exceed the losses, or the 
business cannot continue. 

Variability of Profits. — Profits act as a sort of buffer be- 
tween prices on the one hand, and interest, wages, and rent 
on the other. Prices fluctuate owing to changes in the supply 



31 6 Economics for the General Reader 

of raw materials and in the demand for finished products; 
the worker, capitahst, and land-owner want a steady price 
for their labor, capital, and land; the owners of businesses 
give them a steady price — regular wages, a uniform rate of 
interest, a uniform rate of rent, and take the price of the 
commodity made, making big profits if the price obtained 
for the output as a whole is good, and small profits or losses 
if the price obtained is bad. That it is the owners of businesses 
who take the chief risks is clear when we remember that they 
have paid for the labor, capital, and land before the commodity 
is finished, often before its price can be known, and if the 
commodity when made is not wanted and cannot be sold, 
they cannot recover the wages, interest, and rent expended 
in the production of it. As we have seen, there is a tendency 
to separate the work of organizing or managing production 
from the taking of risks. The management of businesses 
is put into the hands of managers and managing directors, 
paid, like foremen, a regular wage or salary ; the risks of the 
market are borne by the owners of the businesses. In the 
most highly organized trades the separation is carried further. 
The businesses engaged in manufacture are relieved of the 
risks of the market, they work only on contract or commission, 
and the middlemen for whom they work specialize in the taking 
of risks. 

Differential Advantages and Profits. — A third important 
element in profits is the income to be gained from any ad- 
vantage over competitors; for any such restriction on com- 
petition prevents competition from beating down selling 
price to cost of production. When sellers compete freely 
and methods of production do not vary much from firm to 
firm, the price that any can get for their product will be kept 
close to their cost of production ; the firm that tried to raise 
its price would simply drive its customers to other firms which 
were content with a smaller profit over cost of production. 
If, however, one firm in a trade has some advantage in pro- 



Interest and Profits 317 

duction shared by none of its competitors, it can get the same 
price as they do for the product, and, producing cheaper, 
make a larger profit. So important are the variations in 
productive efficiency of different pieces of land that the in- 
come derived from land, rent, is usually treated separately 
from the income derived from capital ; but *' the rent of 
land," in Dr. Marshall's words, " is seen, not as a thing by 
itself, but as the leading species of a large genus." ^ Any 
process, machine or material which cheapens production 
gives its users a differential advantage in production and 
enables them to draw a " rent," so long as its use is restricted 
to a minority of the firms in the trade. The desire for such 
profits is the chief stimulus in modern industry to the im- 
provement of organization and the invention of new processes. 
Monopoly and Profits. — Similarly anything of the nature 
of monopoly enables the monopoHst to draw profits above 
the average. Since buyers must come to him, he need not 
fear competitors, and is, not compelled therefore to keep his 
price near cost of production. A patent is such a monopoly. 
To secure such monopoly, however limited, is the chief ob- 
ject of advertisement. The advertiser aims at so impressing 
the consumer's mind with the desirability of his article that 
the consumer will insist on having it, and will refuse all sub- 
stitutes ; then he exploits this conviction in the consumer's 
mind by charging more for the article than he could do if 
the consumer were not so determined to have it. A well- 
known brand or trademark, the reputation of an old es- 
tablished firm, a prominent situation in an important street, 
a special flavor in a cocoa, tobacco, or snuff, all enable the 
seller to obtain from the consumer a higher price than he 
could otherwise command, because the consumer does not 
adopt his usual practice of beating down prices by playing 
off one seller against another. The " good-will " of a firm 
consists in the limited monopoly the firm has of the custom 
^ Principles, 6th edition, p. 412. 



3i8 Economics for the General Reader 

of a section of the consuming public. The entangling of a 
poor customer in debt is a common device to secure the monop- 
oly of his custom. All these devices have it for their object 
to restrict competition, and so to escape the pressure which it 
exerts, forcing prices down towards the cost of production. 

In addition to interest, then, there are three important 
elements in profits : payment for management and organiza- 
tion; payment for undertaking risk; and the revenue that 
can be derived from any restriction on competition. The 
profits of a firm may consist of one or two of them, or it may 
include all three ; moreover, profits may or may not include 
interest. In every case profits are the portion of the revenue 
of a business which goes to the owners, and are arrived at 
by deducting total expenses from total receipts; but ex- 
penses include different elements in the case of different types 
of firms. In the case of a private firm working entirely on 
borrowed capital, interest on capital will be an expense and 
will form no part of the profits ; in the case of a private firm 
working on its own capital entirely, interest on capital will 
form a large part of the profits. In the case of a corporation, 
interest on bonds is treated as an expense and does not ap- 
pear as an element in profits, while interest on common stock 
is not kept distinct and so forms a part of the profits, which 
are distributed to the common stockholders as dividends. 
Again, in the case of management, the proprietor of a private 
firm may pay himself no salary — in the case of a small 
firm it is very unlikely that he will — and payment for 
management becomes an important element in profits. In 
a corporation all payment for management is made in the 
form of salaries and regarded as an expense, so that it forms 
no part of profits. Payment for the bearing of risk and the 
revenue derived from restrictions on competition cannot be 
so easily distinguished from the other elements in the revenue 
of a business, and are always drawn by the owners of the 
business as profits. 



Interest and Profits 319 

Variable Significance of the Elements in Profits. — It is 

important to bear in mind these diflferent elements in profits 
when we come to compare profits in different industries or 
occupations. The rate of dividend on capital is not the only 
thing to be considered. We must consider the diflficulty 
and amount of work required to manage the different indus- 
tries ; we shall expect profits to be much higher in propor- 
tion to capital in a merchanting business that turns over its 
capital half a dozen times in a year, than in a railway that 
turns over its capital only once in ten years. We must consider 
the risks of the industry ; if risks are great, we shall expect 
the rate of profit, when profits are made, to be high, in order 
to counterbalance the occasional losses which the nature of 
the business makes inevitable. To get the true rate of profit, 
we shall take the average earnings of a business for a number 
of years, and we shall deduct from the profits of successful 
firms the losses of unsuccessful firms. We must also know 
whether the trade is new ; if it is new, apparent profits will 
be higher than they will become later, for three reasons : the 
risks of a new industry are less understood and the chances 
of loss therefore greater ; the work of organizing a new busi- 
ness requires greater ability than the work of running an old 
one, and commands, therefore, a higher remuneration ; and 
the number of firms in a new industry will naturally at first 
be insufficient to meet the demand. The period of high prof- 
its in a new industry is usually preceded by a period of un- 
remunerative expenditure on experiments, advertisements, 
etc., and followed by a period of depression, owing to the over- 
production which the high profits induced ; finally, the trade 
settles down, and supply is so adjusted to demand that the 
trade as a whole makes profits which are neither exception- 
ally high nor exceptionally low. In comparing the profits 
of different firms in the same trade, we shall look chiefly 
to the ability of the management, especially in the matter 
of anticipating demand and supply; but we shall also look 



320 Economics for the General Reader 

to see what firms have differential advantages in production, 
and what firms partial monopolies. 

II 

Why Is Interest Paid? 

Profits, then, include other elements beside the earnings 
of capital ; interest is simply the " earnings " of capital. 
Interest presents us with two problems : (i) why is interest 
paid, and (2) what determines the amount of interest. 

" Risk " in Interest. — There is, however, a preliminary 
difficulty, which we must consider first; apparently capital 
earns different rates of interest in different employments. 
Pawnbrokers charge interest at the rate of 25 per cent to 
50 per cent on their loans ; governments borrow money at 
the rate of 3 per cent to 3^ per cent ; municipalities pay a 
little more; banks pay a low rate of interest on deposits, 
but may charge stockbrokers and other borrowers on call 
even less; common stock in a company usually receives 
interest at a higher rate than preferred stock, and preferred 
stock than bonds. Why this variation ? The explanation is 
that " interest " in some of these cases includes elements 
that should strictly be called " profits," and in all the cases 
allowance is made for risk of nonpayment of interest or loss 
of principal. The pawnbroker charges in the form of in- 
terest for his labor in managing his business and the trouble 
he will be put to in selling the pledge if the loan is not repaid ; 
the stockbroker gets his loan cheap, because he relieves the 
bank of some of the work of finding investments for its funds, 
and because he takes the loan on extremely inconvenient 
terms as to repayment. In the other cases the rate of in- 
terest varies simply with the risk run; the rate is lowest 
when the security for interest and repayment of principal 
is greatest. 



Interest and Profits 321 

Basis of Interest. — An answer to our first question, why 
is interest paid, is necessary if we are to answer our second 
question, what determines the amount or rate of interest. 
Interest is paid for the same reason as all other payments 
are made, because a loan confers a service ; there are always 
people willing to pay interest, because a loan will enable them 
to satisfy their wants. The service rendered by the loan 
varies with the use to which it is put ; there always is a serv- 
ice, because a loan is a loan of wealth, and gives the borrower 
for the time being the same command of wealth as ownership 
gives. A loan is usually spoken of in terms of money — a 
loan of $5,000 or whatever the sum may be — but money only 
measures the amount of the loan ; what the borrower wants 
and gets is the goods and services that the money buys. 
Neglect of this truth has led many people to ignore the true 
nature of a loan ; in the Middle Ages no objection was made 
to payment for the use of a house or land (rent), but pay- 
ment for the use of money — which was only wanted in 
order to buy a house, land, or some other form of wealth — ■ 
was called usury and made illegal. The essence of a loan 
is that the borrower gets the use of some of the lender's 
wealth, and can derive from it all the satisfactions and serv- 
ices that wealth gives; for this he is willing to pay. The 
simplest way of regarding interest is as payment for the use 
of wealth, which the owner could use himself if he did not 
lend it to the debtor. 

Use of Loan in Production. — The commonest use to 
which a loan is put to-day is to assist production. With 
the money borrowed buildings are erected and machinery 
bought. By the aid of these implements of production the 
business man, who obtained the loan, and his staff of workers, 
are enabled to produce far more than they could have done 
without these implements ; they are willmg therefore to pay 
a portion of the product to the lender of the implements. If 
no medium of exchange were in use, and payments for serv- 



322 Economics for the General Reader 

ices were all made in kind, then out of every piece of cloth 
made a portion would go to the weaver as wages, a portion 
to the capitalist who advanced the loom as interest, a por- 
tion to the owner of the land and buildings, which housed the 
loom, as rent, and smaller portions to all the foremen, man- 
agers, enginemen, etc., whose work is needed in a weaving 
factory, a portion to the firms which supplied the yarn, 
coal, etc., the residue going to the owner of the business as 
profits. Similarly in the machine shop where the loom was 
made, a portion of the cloth given in exchange for it would 
go to the laborers making it, a portion to the owner of the 
machines which these laborers used, and so on. In every 
act of production in modern industry, manual work, organiz- 
ing work, capital in the form of machines and power plant, 
and land, cooperate and, because they cooperate, share in 
the product. Interest is paid for the use of capital, because 
the capital is productive ; it enables its user to produce more 
than he could without it, and out of thus additional product 
interest is paid. Where the capital is misapplied so that it 
produces nothing, either the profits of the business are drawn 
upon to pay interest on it, or, as is very often the case, no 
interest is paid. 

A loan of wealth, obtained for purposes of production, 
may be of assistance to the borrower in a different way, and 
so induce him to offer interest for it. It enables him to get 
finished goods which will tide him over the time between the 
beginning of the manufacture of a commodity and the sale 
of the finished commodity. By getting the finished goods 
that he needs for daily use and consumption now he is enabled 
to take his time over production, and thereby produce more. 
He can adopt a system of very extensive and detailed divi- 
sion of labor, which makes manufacture roundabout and 
lengthy, but very productive ; by being enabled to wait, he 
is enabled to produce more, and out of the additional product 
he can pay interest. It pays him, therefore, to offer to re- 



Interest and Profits 323 

pay in the future, when he will have completed the produc- 
tive operation for which he needs the loan, the whole sum 
advanced and interest in addition, if by so doing he can get 
money to buy the finished goods and the services that he needs, 
immediately. A people that has no capital is forced to live 
from hand to mouth, and, being unable to carry the division 
of labor far, is materially poor. 

Consumption Loans, — Not all loans are obtained for pro- 
ductive purposes. The most eager borrowers are individual 
spendthrifts and governments at war. They offer interest, 
though the loan will not enable them to increase their in- 
comes and so pay the interest ; they are simply mortgaging 
future resources to satisfy present wants. Why do they do 
so? Their motive is"* the intensity of their present need. 
The spendthrift is intensely conscious of his want of money 
now; he does not realize with anything like the same in- 
tensity that he will probably want money just as much in 
the future, when he has to repay the loan ; he probably thinks 
that something will " turn up " before then. Any one, there- 
fore, who will supply him with money now is doing him a 
service for which he is willing to pay. Similarly, the Secre- 
tary of the Treasury must have money for war — even a 
nation of shopkeepers never considers expense in deciding 
about war — he risks great unpopularity if he proposes any 
further taxation now ; on the other hand, loans will have to 
be repaid by future generations, and a statesman incurs no 
unpopularity by throwing on to the shoulders of future gener- 
ations the obligations incurred by his own ; he therefore 
" finances " his war by a loan. 

In every case interest is offered because a loan confers 
a service ; for the same reasons the lender expects to receive 
interest. By making the loan he gives up the use of a por- 
tion of his wealth ; he expects compensation. It is not enough 
that he will get back his wealth some time in the future ; 
meanwhile he is being deprived of the satisfactions he could 



324 Economics for the General Reader 

have got from its use. If the borrower uses the loan to pur- 
chase instruments of production, the lender expects a share 
of the product, since he himself, if he had not made the loan, 
could have purchased instruments of production. If the 
borrower uses the loan as circulating capital, the lender ex- 
pects payment for this service also. Finally, he wants some 
interest to induce him to save. Most people prefer spending 
the whole of their income to saving a portion of it ; present 
wants appeal to them more strongly than future wants. 
" A bird in the hand is worth two in the bush " ; the promise 
of $500 a year hence, even if we have absolute faith that the 
promise will be fulfilled, is not the same to us as $500 now. 
Five hundred dollars a year hence will probably give us as 
much satisfaction as $500 now, but we do not realize that. 
We discount future satisfactions, and we require therefore 
some inducement to postpone satisfactions to the future, 
which is what saving means. Society needs capital ; capital 
is not provided free by Nature in unlimited quantities like 
air; society therefore has to pay people to induce them to 
accumulate capital, and interest is the payment. 

Ill 

What Determines the Rate of Interest? 

Supply and Demand Applied to Capital. — We can now 

approach the second question, What determines the amount 
or rate of interest? Interest is the " value " of the use of 
capital, and, like any other value, depends on the relation of 
supply to demand, and in answering the first question, why 
interest is asked and paid, we have reviewed the influences 
that control the supply of capital and the demand for it. 
The supply depends on the willingness and ability of people to 
sacrifice present to future satisfactions ; the demand depends 
on the productivity of capital, and on the intensity of present 



Interest and Profits 325 

need that induces people to mortgage future income in order 
to secure an increase of present income. 

Interest and Saving. — The willingness of people to save 
is largely a matter of social habit, the ability to save depends 
on the amount and distribution of wealth. Saving always 
involves a sacrifice of present for future satisfaction ; to in- 
dividuals and communities who are poor the sacrifice is great ; 
to individuals and communities who are rich it is small, 
and may even become negligible. So long as there is any 
sacrifice involved in saving, the supply of capital will always 
be less than the possible uses of capital, and interest will 
be necessary to keep up the supply. What influence changes 
in the rate of interest (or value of capital) have on the supply 
of capital is uncertain. A rise in the general rate of interest 
may in some cases induce an increase in the supply of capital ; 
usually, however, it will probably have no such effect. The 
accumulation of capital is due mainly to two classes of savers : 
one class, the prudent or timorous people who are anxious 
to secure a certain income from investment, will need to 
save less to secure this certain income if the general rate of 
interest goes up, and will save more easily and rapidly ; the 
other class, people engaged in business, who are anxious to 
increase the size of their business and therefore leave in the 
business each year some of its earnings, will be unaffected 
by the level of interest. In the latter class is included the 
important section of the community which, being determined 
to get rich at any cost, spends as little as it can and saves 
as much as it can, whatever the rate of interest. A change 
in the rate of interest in some particular industry, as dis- 
tinct from a change in the general rate of interest, does affect 
the supply of capital in that industry. Capital is constantly 
wearing out and has to be renewed from gross income ; it 
will not all be renewed if the rate of interest in the industry 
falls below the known rate of interest in other accessible 
industries. On the other hand, if the rate of interest in an 



326 Economics for the General Reader 

industry is high, new capital will be attracted into the in- 
dustry, because there is always a fund of capital awaiting 
investment which will be directed into the industry that seems 
to offer the biggest net return on the investment. 

Demand for Loans. — Of the influences that affect the de- 
mand for loans, the productivity of capital is the chief ; the 
need of individuals and governments for unproductive ex- 
penditure, though still of enormous importance, no longer 
normally controls the market for loans as it did before the 
nineteenth century. The productivity of capital is different 
in different countries and at different times. Capital is al- 
ways used in cooperation with labor and natural resources, 
and as their relative proportions vary, the productivity of 
each varies. If the amount of capital available for industry 
increases without any corresponding increase in labor and 
natural resources, capital can be fully employed only if it is 
put to uses in which it is less productive than it was before. 
On the other hand, if labor or natural resources increase rela- 
tively to capital, capital will become more productive, because 
it will now be withdrawn from the uses in which formerly it 
was least productive and be restricted to its more productive 
uses. The organizers of industry, balancing labor, capital 
and natural resources against one another in order to find 
exactly the most productive combination, employ just as 
much capital as at the current rate of interest gives them a 
profit. Hence the rate of interest and the demand for capital 
are coimected both in industry as a whole and in any single 
industry; a change in one produces a change in the other. 
If a Uttle more capital will enable an organizer to produce 
more or more cheaply, he will offer more for it, i.e. the rate 
of interest will go up ; conversely, if the rate of interest 
falls, he will employ a little more capital. It is always the 
productivity of a little more or a little less capital that the 
organizer considers, and economists therefore speak of the 
" marginal " productivity of capital. The competition of 



Interest and Profits 327 

lenders and borrowers in the money market tends to make 
the rate of interest coincide with the marginal productivity 
of capital ; in other words, the rate of interest depends on the 
relation of the supply of capital to the demand for it, and the 
supply and demand influence each other. 

Capital as Exploited Labor. — The demand for capital is 
explained in a different way by those economists, such as 
Marx, who hold the Subsistence Theory of Wages. Capital, 
they argue, is necessary for any productive work to-day; 
the owners of it, therefore, are able to force the laborers to 
work in return for a subsistence wage, and to take for them- 
selves the rest of the product of industry. We have seen 
reasons for believing that wages to-day are not subsistence 
wages, and the theory seems to assume that all the owners 
of capital act together in industry as a class. If they did, 
the theory would be correct ; but they compete, both to sell 
products and to buy labor, far more than they combine, and 
by competing are forced to give to the laborer more than a 
bare subsistence. This Exploitation Theory has, however, 
important elements of truth. It calls attention to the enor- 
mous social power given, especially in countries which are 
nominally democracies, by the possession of capital. It 
reminds us of the weakness, in a society which allows the 
values of services to be settled by the relations of supply and 
demand, of those members of society who have no reserve 
of wealth. And it reminds us of the historical origin of at 
any rate much of the capital in use at the present day. Capital 
in England has not too creditable an ancestry, for three of 
the chief sources of its growth are the private appropria- 
tion of land-values created by the growth of towns, the 
exploitation of slaves and Asiatics in the seventeenth and 
eighteenth centuries, and the exploitation of child labor in 
the first half of the nineteenth century. In the United States 
the record is a little more commendable, but there are some 
dark pages in it — slums, sweated industry, and child labor. 



CHAPTER XIX 
RENT 

I 

The Ricardian Theory of Rent 

The theory of Rent was given its present importance in 
Economics by Ricardo and his followers. They held that 
the value of a thing is fixed by its cost of production ; they 
sought to apply this theory to agents of production, i.e. to 
find in the cost of production of land, capital and labor the 
principle on which the present distribution of income between 
owners of land, capital and labor is based. Hence they said 
that wages depended on subsistence, i.e. on the " cost of 
production " of the laborer ; interest was the payment needed 
to induce people to save, it was the " cost of production " 
of capital. When they came to land, they could not adopt 
this explanation. They were struck by the obvious fact 
that land, although it has to be paid for, has no " cost of 
production " ; man does not " produce " it, it is there before 
he is, and would still be there if the owners of it received 
nothing for its use. They had therefore to seek another 
principle to explain why rent is paid and how the amount of 
rent is fixed. They found their principle in the natural 
variations in the productivity of land, coupled with the fact 
that the most productive land is limited in quantity. 

No-Rent Land. — Some land wiU not repay cultivation ; 
crops could be raised on it, but the price they would fetch 

328 



Rent 329 

would not be enough to repay the expenses of raising them. 
Other land will just repay the expenses of cultivation, but 
nothing beyond ; the value of the produce is not enough to 
enable the farmer to pay any rent; this land was said by 
Ricardo to be on " the margin of cultivation." Some land, 
however, is so fertile that the value of its produce is 7nore 
than enough to pay the usual rate of wages to the laborers 
employed on it, the current rate of interest on the capital 
applied to it, and the average profits to the farmer cultivat- 
ing it ; this surplus of product over expenses, according to 
the theory, is taken by the owner of the land as rent. Com- 
petition for land among farmers enables owners to secure this 
surplus, due not to any effort on the part either of cultivator 
or owner, but to the superiority of the land over the land 
which only just repays cultivation. Once it is in the market 
one bushel of wheat fetches the same price as any other bushel 
of the same quaHty, whatever its cost of production. If 
the natural fertility of the soil on which it was grown made 
the cost of production low, the saving would go to the owner 
of the soil ; if the soil was infertile or difl&cult of access, so 
that the cost of bringing the wheat to market usually equaled 
the price it fetched, the owner of the soil would be able to 
get nothing for the use of his land. 

Influence of Fertility. — Variations in productivity may 
be due to the differing fertility of different pieces of land or 
to varying advantages of situation. Just as a given applica- 
tion of capital and labor will give a larger return on some soils 
than others, so will a given application of capital and labor 
to shopkeeping give a bigger return on some sites than others. 
The same hat will sell for a bigger price on Fifth Avenue than 
on the Bowery ; more business can be done with a given 
capital in the middle of New York than in the middle of 
Albany. In every case the owner of the better site can secure 
the additional value given to the wares of a shop by its situa- 
tion or the value of the additional facilities afforded to a 



330 



Economics for the General Reader 



business by a central position. The convenient situations 
for offices, factories, and shops, Uke fertile land for agricul- 
ture, are limited in quantity; people who want them have 
to pay for them in proportion to their convenience.^ 



II 

The Law of Diminishing Returns or Increasing Cost 

Statement and Explanation. — Increasing the area of land 
under cultivation is not the only way in which an increased 
supply of agricultural products can be obtained. An ad- 
ditional expenditure of capital and labor on the area already 

^ The nature of rent can be illustrated by a diagram : 
E F 



M 



N 


G H 




K L 









B 



Suppose AB, BC, CD are pieces of land of equal extent, managed with equal 
ability and with the same application of capital and labor and producing wheat 
for the same market ; owing to differences in the fertility of the soU the product 
is different in each case, the product of AB being represented by the rectangle 
AEFB, that of BC by the rectangle BGHC, and that of CD by the rectangle 
CKLD. If the market needs the produce of the inferior land CD, the price for 
the amount of grain represented by CKLD will have to be sujScient to repay 
his expenditure in capital and labor to the farmer who worked the land; 
otherwise he will be driven out of the trade and the land will go out of cultivation. 
Now the same amount was expended on the other pieces of land ; therefore the 
Other farmers will be fully repaid for their expenditure when they have sold 



Rent 



331 



under cultivation will always increase the product. This 
fact, however, does not prevent the phenomenon of rent, 
because it does not prevent recourse to inferior or less con- 
venient soils. Additional expenditure on land already under 
cultivation will produce an increased yield, but the increased 
yield will not be proportionate to the increased expenditure. 
This is the Law of Diminishing Returns or Increasing Cost, 
on which Malthus based his gloomy views of the future of 
society. Successive equal " doses " of capital and labor 

the same amount of grain as was raised on CD. When they have been fully 
repaid, therefore, they will still have an amount of grain represented by the 
rectangles EFNM and GHKN to sell, i.e. this land gives a surplus over the 
amount of produce necessary to pay the cost of raising it. This surplus is 
rent and goes to the owner of the land. Or take this second diagram : 

K L 



Q H 




E F 











A B C O 

AEFB measures not the produce of a given expenditure of capital and labor 
but the expenditure needed to produce 100 bushels of wheat on AB. Then BC, 
being less fertile, will require a bigger expenditure (BGHC) to produce the same 
amount of wheat, and CD a greater expenditure still (CKLD). The price of 
100 bushels must cover the expenditure on CD ; therefore it will more than 
cover the expenditure required to produce the same amount on BC and AB. 
The difference will go to the owner of the land as rent. Similar diagrams would 
illustrate the nature of site-rents, receipts per dollar of expenditure being sub- 
stituted for product in wheat, and the expenditure needed to secure, say, $100 
of business being substituted for expenditure required to produce 100 bushels. 



332 Economics for the General Reader 

applied to land under cultivation, after a certain point in 
the cultivation of land has been reached, produce a diminish- 
ing return per " dose " ; or, to state the same principle 
differently, equal increments of product can be obtained 
from the same land by the same methods only at increasing 
cost. The principle is only true assuming no improvement 
in the mode of cultivation, i.e. that successive " doses " 
are applied in the same form. The result of this principle 
is that different portions of the capital and labor employed 
on the same land produce different returns. There is an 
" intensive " as well as an " extensive " margin of cultiva- 
tion, namely, that expenditure on the land which just " pays " 
at the market price of the product. Now if the market 
price just pays the expenses of raising this last increment 
of the crop, the portions of the crop raised with previous 
applications of labor and capital — being raised when the 
soil was not so near exhaustion — will afford a, surplus over 
cost of production. They will sell for the same price as 
the last increment, but their cost of production, owing to 
the unexhausted vigor of the soil, will be less. The dif- 
ference can be got by the owner of the land as " rent," since 
the tenant, if he objects to paying the rent, cannot secure 
any better return to his capital and labor in any other way ; 
the return to his capital and labor will be less, whether he 
devotes it to the further working of good land already under 
high cultivation, or to working additional but inferior land 
not yet cultivated with equal intensity. The principle of 
Increasing Cost is of course the reason why society does not 
raise all its food by the intensive culture of selected land of 
special fertility. 

Hence the two processes, increasing the area under culti- 
vation and increasing the expenditure of capital and labor 
on the same area, go on simultaneously and have the same 
result; they mean an increased cost of production per unit 
of product on the margin of cultivation, they enable the 



Rent 333 

owners of the land on which production is cheaper to take 
the difference as rent. As population grows, the margin of 
cultivation recedes and rents rise. 

Effect of Improved Methods. — This law of Increasing 
Cost is not noticed, because its effects are constantly being 
counteracted by two influences. Improvements in transport 
enable crowded countries to draw on the resources of distant 
lands, and improvements in methods of agriculture are con- 
stantly enabling us to obtain additional suppHes from the 
same area without increased cost or even at a less cost. The 
construction of the Suez Canal enabled England to import 
from India wheat which would not stand the longer voyage 
round the Cape. The railways of North America brought 
within reach of the EngHsh market the virgin soils of the 
Middle West. Similarly the gradual adoption of the four- 
course rotation of crops by English farmers in the late eight- 
eenth and early nineteenth centuries enabled them to carry 
much more stock on their land than had been possible before. 
There is a constant race, as population grows, between science 
and this tendency of nature to give increased supplies only 
at greater cost ; since the middle of the nineteenth century 
the advantage has rested with science. 

Site-Value. — Site-values are subject to a tendency similar 
to the law of Increasing Cost in agriculture. Existing sites 
can always be improved, but at increasing cost. The cost 
of improvements in the centers of large towns illustrates this 
tendency ; more use is got out of the same extent of land as 
a result of the improvements, but the cost is greater and 
greater as the size of the towns increases. Additional stories 
can be added to existing buildings to save the expense of 
buying new sites, but the additional accormnodation thus 
obtained is either less convenient than that of the lower stories, 
or, if equally convenient, is more costly. Improvements in 
means of transport and communications act as a check on 
this tendency towards increasing cost in sites, by extending 



334 Economics for the General Reader 

the area over which the relations of a business center can 
be effectively maintained. Improvements in methods of 
construction enable more effective use to be made of sites 
already in use, just as advances in agricultural science enable 
increased produce to be obtained from soils already under 
cultivation. 

HI 

Rent and Cost of Production 

Relation between Rent and Prices. — Rent, then, is due 
to differences in the productivity of different pieces of land, 
the users of which are working for the same market, dif- 
ferences over which the owners have no control. From this 
the corollary is drawn that rent does not enter into the cost 
of production. " Corn," in Ricardo's words, " is not high 
because a rent is paid, but a rent is paid because corn is high ; 
and it has been justly observed that no reduction would 
take place in the price of corn, although landlords should 
forgo the whole of their rent." The latter part of Ricardo's 
statement is not strictly accurate. If the landlords would 
forgo their rents, not to their tenants but to the State, the 
State could, as it were, pool all the land of the country, and 
sell the corn raised on the worst lands below its cost of pro- 
duction, compensating itself from the surplus of product 
over outlay on the best lands, i.e. rent as a whole enters into 
cost of production as a whole, prices as a whole would be lower 
if no rent were paid ; but any particular rent does not affect 
the price of the product of the land for which it is paid, it 
depends on that price. Ricardo, however, had in mind not 
the State but the tenant, and for landlords to forgo their 
rent to their tenants would not relieve the consumer. The 
surplus of product over outlay on land that was within the 
margin of use would remain, being something for which neither 
land-owners nor land-user is responsible. Under the system 



Rent 335 

of private ownership it is true to say that rents depend upon 
prices, not prices upon rents. 

Causes of Confusion. — The difficulty that is usually 
experienced in grasping this principle is due to the difference 
between the individual and the social point of view. Most 
people look at rent from the point of view of the individual. 
They see that the farmer regards his rent as a cost, a pay- 
ment made for so much productive power, just as much as 
the interest he pays on borrowed capital or the wages he pays 
for labor ; he has to insist on a price for his output sufficient 
to enable him to pay rent, as well as interest and wages, or 
he cannot continue farming. His rent is a part of his cost 
of production, which determines the minimum price he can 
take for his total produce. From the point of view of society, 
however, we are not concerned with the price which the farmer 
must charge for bis whole output, but with the minimum 
price for which a bushel of wheat can be got, and the mini- 
mum depends, not on the cost of production of a bushel of 
wheat on land which pays a rent, but on the cost of production 
on land which only just repays the expenses of working with- 
out affording any surplus for rent. It is this part of the total 
produce coming to market which fixes the minimum price 
society must pay, because society will not have all it wants 
without this part, and this part will not be produced if the 
price falls below this minimum. The produce of better land 
costs less to produce ; it is sold at the same price per bushel 
or ton ; the saving due to the superiority of the land goes 
to the owner of the land as rent. His rent is the result of 
the high price ; the actual expenditure on labor and capital 
on his land does not affect the market price. What the 
tenant of the better land pays in rent is balanced by the in- 
creased amount of produce which he gets owing to the su- 
perior fertility (or accessibiUty) of his farm. Farmers with 
equal capital and skill but less fertile or accessible land get 
less produce from their land; they get no bigger price for 



336 Economics for the General Reader 

the bushel of wheat, but can make the same net income, 
because their smaller output is balanced by the lower rent 
they pay for their less fertile or accessible land. From the 
point of view of the individual, rent is an element in the nec- 
essary cost ; he must be able to meet it or he cannot continue 
in his business ; from the point of view of society, it is not a 
necessary element, because the total amount of produce 
would not be diminished if it were not paid. The market- 
price is sufficient to remunerate the labor and capital em- 
ployed on the worst land in use, and more than sufl&cient, 
therefore, to remunerate the labor and capital employed on 
the superior lands; if no payment is made for the superior 
lands, their quantity and quality will not be affected. Since 
land is largely in private hands, the owners are able to get 
payment for its use, but the payment they can get depends 
on the price which their tenants can get for the portion of 
the produce due to the superior fertility of their land, the 
tenant simply handing over to the landlord the price he 
receives for the additional produce. 

Social Importance of Rent. — This principle, that the 
productive powers for which rent is the pa3Tnent are inde- 
pendent of pajnnent, i.e. are not called forth by the offer of 
payment, and will not languish if payment be stopped, is 
of fundamental social importance. Prices depend on costs 
of production in the sense that unless the prices paid are big 
enough, on the whole and in the long run, to cover costs of 
production, goods will not be supplied. The productivity 
of land for which rent is paid is not affected by the payment of 
rent. It is due to natural variations in soils, or to the varying 
advantages given to sites, not by the owners of the sites but 
by the distribution of population and the means of trans- 
port. If the payment of rent were stopped, the fertility of 
good soils, the convenience of good sites, would not diminish ; 
for the rent-receivers did not create, and do not maintain, 
that fertility and that convenience. They might, as a matter 



Rent 



337 



of tactics or from a " dog-in-the-manger " temper, with- 
hold their land from use ; but they would do themselves no 
good by so doing. If wages are not paid, on the whole people 
will not work ; if interest is not paid, on the whole people 
will save less ; if rent is not paid, the quantity and quality 
of land will not be affected. Wages have to be paid by society 
to maintain the supply of labor; interest has to be paid to 
maintain the supply of capital; the supply of land is not 
affected by the payment of rent. 

IV 

Application of the Ricardian Theory to Actual Conditions 

Ricardian Concept of Rent vs. Popular Concept. — Before 
we develop the consequences of the Ricardian rent theory, 
however, we must pause to consider some difficulties in the 
application of the theory to actual conditions. The first 
difficulty is that the economist gives a meaning to the word 
"rent" different from its meaning in ordinary speech. In 
ordinary speech rent is the pa^nnent made for the use of any 
kind of real property ; Ricardo restricted the term to the pay- 
ment made for the " original and indestructible qualities of 
the soil." Ricardo's justification is that " rent " in ordinary 
speech covers payments which are different in kind. The 
rent of a house includes interest on the capital embodied 
in the house and amortization, as well as payment for the use 
of the land on which the house stands. Similarly the rent 
of a farm usually includes a good deal of interest on capital, 
embodied in buildings and improvements, as well as payment 
for the use of the bare land. In England, where it is the 
custom for the landlord to provide most of the more per- 
manent improvements, as much as five sixths of the " rent " 
may be interest on capital. It is not too much to state that 
in an old country farm-land is " made," its present value 



338 Economics for the General Reader 

being, as a rule, due hardly at all to any original fertility and 
almost entirely to the constant investment of capital in it. 
Clearing, draining, road-making, fencing have all to be done 
before the " original and indestructible quaHties " can be 
utilized. 

Rent, again, in the sense in which the word is used in 
ordinary speech, occurs only when the holder of the land is 
not the owner. In Great Britain, where the theory of rent 
arose, the custom has been for a century and a half for land 
to be farmed by tenants, the owners of the land supplying 
the more permanent forms of capital, but not taking any 
active part in the work of cultivation. But this system of 
land-tenure is exceptional ; the vast majority of the world's 
farmers own the land they cultivate. But though no pay- 
ment is made for the use of the land where the owner cul- 
tivates, the surplus of product over outlay due to differential 
productivity, which constitutes "economic" or "Ricardian" 
rent, occurs and goes to enrich the owner of the land. This 
pecuHarity of English agriculture has influenced, one might 
say sidetracked, the course of economic studies. The eco- 
nomic condition of an agricultural population depends much 
more on the distribution of landed property than on the dis- 
tribution of the income from land between rent-receivers, 
interest-receivers, and wage-receivers. English economists, 
however, have given much more attention to elucidating the 
latter problem than the former. 

Effect of Absence of "No-Rent" Land. — A difficulty 
often experienced in stud3ang the theory of rent is that, in 
some countries Hke Great Britain, there seems to be no land 
" on the margin of use," no " no-rent " land. Now there 
may be no land for which no rent is required in Great Britain, 
but such a consideration would not upset the theory of rent. 
The British market is served by lands outside Great Britain; 
modern means of transport bring into competition with 
British grain the produce of every habitable continent; so 



Rent 339 

that the margin of cultivation for the British market may be 
in northwest Canada or Australia or the Argentine. In 
Great Britain, where, on the whole, more capital and labor 
are applied and a bigger produce per acre is obtained than 
in any other country, the margin of cultivation would be an 
intensive not an extensive one. It is not, however, certain 
that there is no " no-rent " land in Great Britain. After 
allowance has been made for interest on the capital invested 
in permanent improvements on many English farms, there 
will be nothing left to represent payment for the " original 
and indestructible qualities of the soil." Again, land does 
not occur in compact blocks nicely graded. Land is let in 
farms, and every farm includes some good and some bad 
land. Payment is made at the rate of so much per acre, the 
acres of bad land paying something more than their economic 
rent, the good acres something less. Because good and bad 
is usually combined in this way, it is possible to quote a nor- 
mal " rent per acre " for a whole district, that being the rate 
at which most of the tenant-farmers in the district pay for 
their farms. 

Basis of " Productivity " for Rent Calculation. — It must 
not be forgotten that land has many uses, and there may 
be several " margins," without there being any " no-rent " 
land. Land may be " marginal " for building purposes and 
yet give a bigger return for a given expenditure of capital 
and labor than the same extent of land on the agricultural 
margin. It may be useless for agriculture and yet have a 
value for sport. In England, with its dense population, 
some use can be found for most land, and the values of land 
for different uses are curiously affected by the desire for land 
as a means of ostentation or sign of social status ; more will 
often be paid for land to keep it idle, in the form of a park, 
than would be paid for the same land for the purpose of wheat- 
growing or sheep-farming ; the " pheasant margin " may be 
higher than the " peasant margin." 



340 Economics for the General Reader 

Finally, we have seen that fertility and site-value are 
relative to agricultural science and the means of transport. 
An improvement in either of these will effect a widespread 
change in the relative productivity of different pieces of land. 
The example usually quoted is the new value for wheat-grow- 
ing given to sandy soils by the introduction of turnips into the 
rotation of crops. Urban site-values in the United States 
have been greatly altered in recent years by the construction 
of electric street railways, subways, etc. Science is con- 
stantly lessening differences and redistributing fertility and 
site-values. But differences remain, and give rise to eco- 
nomic rent, and the Ricardian theory, in spite of all these 
qualifications, remains important. 



CHAPTER XX 

RENT {Continued) 

A 

" Rent " Elements in Wages 

Complementary Relationship of Productive Agents. — Rent, 

in ordinary speech, is the payment made for the use of real 
property. We have, however, seen that the essential charac- 
teristic that distinguishes rent from other forms of income is 
that it is the outcome of differences which are not due to 
owner or user, and are therefore independent of the payment 
made to them. From the point of view of the payer of rent 
there is no difference between Land and the other agents of 
production. Labor and Capital. Farmers regard their rent 
as a payment that must be made if they are to carry on their 
business, precisely in the same way as the payment of wages 
for labor, or interest on borrowed capital. Manufacturers 
regard any rent they pay for the site of the mill as a cost 
like any other cost. The important question for the entre- 
preneur is, ** How shall I get most productive power for my 
money? " and he expends his resources (derived ultimately 
from the sale of his products) on land, labor, or capital ac- 
cording as each increases their output. He needs all three, 
it is always a matter of a little more or a little less of each ; 
so that we may say, if we like, that it is their " marginal " 
productivity that determines his emplo)rment of them, and 
therefore their value. From this point of view there is no 

341 



342 Economics for the General Reader 

difference between Land, Labor, and Capital; each is paid 
for on account of its productivity, and, if we grant the rather 
large assumption that the bargaining powers of land-owners, 
workers, and capitalists are equal, we may say that each is 
paid in proportion to its productivity, i.e. to the aid it gives 
in the production of value. Land, from the side of demand, 
is simply a requisite of production, paid for in accordance 
with its productivity. It is on the side of supply that the 
differences between land and the other agents of production 
occur, and the theory of rent is emphasized most by those 
economists who, like Ricardo, approach all questions of value, 
including the value of the agents of production, from the side 
of supply. 

Differential Elements in Other Incomes. — Now the rent 
of land is the most obvious, but not the only, case in which 
an income is derived from differences in the productivity 
of an agent of production which are not due to the persons 
who supply that agent of production. A similar element can 
be discovered in incomes derived from work and incomes de- 
rived from capital, if these incomes are approached from the 
same side as Ricardo approached income from land, namely, 
the side of supply. The phenomenon of economic rent is most 
clearly seen in the case of land, because it is possible to find 
" no-rent " land, on the " margin of cultivation," which shows 
up the differential productivity of " rent " land. It may be 
diflScult to find any marginal labor or capital, but it is quite 
easy to find different levels of productivity in labor and 
capital, differences which are not due to the persons who 
supply the labor or capital, any more than differences in the 
fertility of the soil are due to land-owners. The test of the 
existence of an element of economic rent in wages and profits 
is the same as in the case of land rent : Is the productivity 
of the agent evoked by and dependent on the payment for 
it, or is it unaffected by payment ? 

Labor. — The case of labor may be taken first. It is easy 



Rent 343 

to find important cases when quantity and quality of work 
are almost entirely independent of the payment made. Genius 
is such a case. The great quantity or fine quality of a gen- 
ius's work is not evoked by the amount of payment ; it is 
due to the natural endowment of the genius, just as the fine 
quality of the products of Champagne vineyards is due to 
natural endowment. In most professions there is a standard 
income towards which most actual incomes gravitate and 
with which most members of the profession are satisfied. 
So long as they get this standard income, the best members 
of the profession work irrespective of payment. Their motive 
is interest in their work ; the best work is done for the sake 
of the work. Great surgeons may charge a thousand dollars 
for a single operation, but they would exercise just as much 
skill if they could get only ten dollars; the difference is a 
" rent," which represents society's valuation of the difference 
between the great surgeon's skill and the " marginal " sur- 
geon's skill. The great surgeon takes it because he can get 
it, but he performs exactly the same operation for nothing in 
the public hospital. Members of the Civil Service of the 
same grade do not all do the same amount of work ; they all 
receive the same pay, and one never hears of the hard or 
specially gifted workers among them demanding payment 
in proportion to their productivity. The same differences 
in productivity, without differences of payment, are common 
among manual workers. The manual worker, we have seen, 
like the professional man, demands his standard wage and 
does not worry much about anything more; employers can 
often induce him to increase his output by, say, a sixth by 
an increase in pay of only a twelfth. No class of worker 
perhaps is indifferent to pay, but productivity is seldom 
strictly proportionate to pay. 

Variations in the productivity of workers are as great 
as variations in the productivity of land ; to a large extent 
the former are as little influenced by the prospect of pay- 



344 Economics for the Getieral Reader 

ment as the latter. It would be possible to frame a Theory 
of Wages parallel at all points with the Theory of Rent. 
Subsistence wages would represent the margin of production ; 
the return equals the outlay and gives no surplus. Most 
workers, however, receive more than a bare subsistence. In 
one class of cases this is due to the investment of capital in 
the worker in the form of special training; in this class 
wages correspond to the rent of farms on which there has 
been a large capital outlay in permanent improvements, 
producing a return apart from and above any " economic 
rent." In another class a surplus of wages over subsistence 
is earned because the natural endowment of the workers is 
exceptional ; such incomes have been called " Rent of Ability," 
and correspond to fertiUty rent in the case of land. There 
is a third class whose wages have an element corresponding 
to site rents in the case of land. This is the case of workers 
who owe the surplus of the incomes over subsistence to re- 
striction of their number, owing to class distinctions, monop- 
oly of educational opportunity, and similar causes. The 
"cost of production" of a doctor is not very much greater 
than the " cost of production " of a janitor ; allowance must 
be made for the capital expenditure on the doctor's training, 
but after interest on that expenditure has been allowed for, 
there remains a great disparity of income. This disparity 
would seem to be due to the fact that though there are any 
number of people with brains enough to make doctors as 
good as the average practitioner, only a small proportion 
of them have the opportunity of a medical training, so that 
the supply of doctors is, compared with the supply of janitors, 
small. Such a theory of wages, reached by approaching the 
problem of the value of different kinds of labor, from the side 
of supply, is not inconsistent with the Marginal Productivity 
explanation of wages ; it is at least as successful in bringing 
out the socially important influences on wages. It directs 
attention to the inequality of social opportunity which is 



Rent 345 

the chief cause of inequality of income, and it reminds us 
that much work — including most of the work that requires 
the finest and rarest qualities — is done from no economic 
motive at all, but in return for the interest and pleasure of 
the work, or from a sense of duty. 

II 

"Rent " Elements in Profits and Interest 

Capital. — Different levels of productivity can be found 
in the case of capital also, equally unaffected by payment. 
The capital invested in land in so-called " permanent " im- 
provements, once it has been so invested, gives a return 
fixed in precisely the same way as the rent of the land itself. 
The usage of ordinary speech which applies the term "rent" 
to the payment for any form of real property has a good eco- 
nomic basis. Drainage schemes, roads, fences, buildings are 
all like agricultural land in this, that their value depends on 
the prices of agricultural produce, not vice versa. When 
English agricultural rents fell after 1879 the fall was not 
confined to " economic " rent ; it extended to all incomes 
derived from permanent improvements of land. Similarly the 
plant of an old firm often affords an income indistinguishable 
from rent. The income it affords depends on the price of 
its product ; if the price is high, it will make a big income 
for its owner, but if prices fall it is not withdrawn from use. 
It will remain in use so long as the price affords any surplus 
over the bare expenses of labor, material, and wear and 
tear. When only the ordinary bare expenses are made by 
the sale of the product, it may be called " capital on the 
margin of production," or " no interest " capital. 

Rent Element in Fixed Investments. — The return to all 
fixed capital, if a short period is under consideration, partakes 
of the nature of economic rent, i.e. it depends on prices, not 



346 Economics for the General Reader 

prices on it. In the long run the price of the product has to 
afford interest on the capital, or investment in the industry 
will cease ; similarly a rise in prices followed by a rise in the 
return to capital already in the industry will in the long run 
attract new capital into the industry ; but a fall in prices 
reducing interest can seldom affect the supply of capital in 
an industry for some time, and new capital cannot be put 
into an industry the moment a rise takes place. There is 
an interval while plant in existence is wearing out or new 
plant is being constructed; in that interval earnings of the 
plant in existence depend on prices ; the owners of that plant 
are like land-owners, they do not control the productivity 
of their property; if prices are low, their property brings 
them in nothing, if high it brings them in much. The profits 
and losses of business enterprise are due largely to fluctua- 
tions in the earnings of invested capital in this interval be- 
tween the change in the demand for the products of the capital 
and the adjustment of the supply of capital to the changed 
demand. We have said that in the long run the price paid 
for the services of an industry has to cover interest at the 
average rate on the capital invested in the industry, or new 
capital will be diverted from the industry and the supply of 
its services curtailed. Where, however, the original cost of 
the plant of an industry is high in proportion to the working 
expenses, and the plant takes a long time to wear out, the 
" long run " may have to be a very long run indeed for supply 
to be affected, and the " short run," during which the re- 
turn to the capital is governed by the same influences as the 
return to land, may be a long period of time. There are 
railways still working that have paid no dividend for a genera- 
tion. 

Invested capital, then, like land, has different levels of 
productivity, independently of payment. There is reason 
also to believe that the flow of new capital, from which re- 
placements and additions to invested capital are made, 



Rent 347 

includes elements which are not influenced by the rate of 
interest ; in the last paragraph we were considering capital 
in an industry, in this we consider the supply of capital as 
a whole. The three chief sources of the accumulation of 
capital, we saw, are the savings of prudent people, who wish 
to provide for future contingencies, the increase of business 
capital by men who never draw out from their businesses at 
the end of the year the full amount of the year's earnings, 
and the " savings " of men so rich that they cannot spend 
their whole income. Now the action of all these classes is 
of the nature of habit or social instinct rather than reasoned 
calculation, and will not be afifected by a change in the rate 
of interest. So far as the first class does calculate exactly 
what they will want in the future, a fall in the rate of interest 
will, as Dr. Marshall points out, lead them to save more, 
since larger savings now are needed to give, at the lower 
rate of interest, the required income in the future. The 
second class either adopt a conventional standard of ex- 
penditure and leave in their businesses all that is over, how- 
ever much it may be, once this conventional expenditure 
has been met ; or they are anxious to get rich quick, cut 
their personal expenditure down to a minimum, and save 
as much as they possibly can, whatever the rate of interest. 
The third class can hardly help saving. It is true that the 
rate of interest controls the supply of capital in any particular 
industry, it is not true that it is the determining influence in 
the supply of capital as a whole. 

Significance of Ricardian Theory. — The difference, then, 
between the return to land and the return to labor and to 
capital is not so great as Ricardo suggested. The Ricardian 
analysis of rent can be applied to wages and to profits and 
interest. The difference between land, labor, and capital 
in this respect is one of degree only. There is a difference. 
It is not, to repeat, on the side of demand ; the demand for 
all three agents of production is due to the assistance they 



348 Economics for the General Reader 

give to production, and the payment that will be offered will 
tend to be proportionate to the amount of that assistance. 
The difference is on the side of supply and amounts to this, 
that the supply of different kinds of land is much less under 
the control of man than the supply of different kinds of 
labor or capital; it is more difficult to increase the supply 
of land for a particular use than it is to adjust the supply of 
labor or capital to a change in the demand for them. The 
rise of each new generation gives an opportunity for the 
readjustment of the supply of labor to changing needs, and 
this readjustment is always going on ; in much the same way 
the constant wearing out of capital and the accumulation 
of new capital enables a constant readjustment in the appHca- 
tion of capital to changing needs. But the difference is one 
of degree only; the supply of labor and capital are not en- 
tirely under the control of their owners, the supply of land 
is not entirely out of the control of man. " Capital " merges 
into land in practice ; an expenditure of capital on transport 
is equivalent to increasing the supply of land, and there is 
a continuous gradation from the return to an investment of 
capital on a drainage scheme, which is indistinguishable from 
land rent, to the extra return on capital invested in a stock 
of mourning goods when a death in the royal family creates 
a sudden demand for them. In each case the return depends 
on the price, the price does not depend on the cost of the 
capital ; in the case of the drainage scheme that will always 
be the case, since drainage schemes last as long as land; in 
the case of the stock of mourning goods the differential value 
soon disappears, since the supply of mourning goods lends 
itseff easily to rapid expansion and contraction to meet 
changes in demand. In fact the Ricardian Theory of Rent 
is not so much a new explanation of land incomes, as a new ap- 
proach to the problem of distribution as a whole. 

Value-output and Rent. — There is another aspect of 
rent of importance from the point of view of society. The 



Rent 349 

rent of land is due to the superior productivity of some land 
over other ; and the superior land enables the user to obtain 
a bigger return for the same expenditure of labor and capital. 
Now this bigger return may take the form of a bigger output, 
as in the case of fertility rent ; but it may also take the form, 
not of an increase in the output, but of an increase in the 
value of the same output — as in the case of the hat which has 
a value of five dollars on Fifth Avenue, and only two dollars 
on the Bowery. The "productivity " for which rent is paid is 
not necessarily the same thing as output ; it is productivity 
of value, not productivity of wealth. The capital and labor 
employed on the Fifth Avenue site bring in a bigger return 
than the capital and labor employed on the other site, not 
because more hats are produced in Fifth Avenue, but because 
each hat produced has a greater value than the same hat 
would have if sold anywhere else. This high value is due to 
the relative scarcity of Fifth Avenue hats ; the number of 
Fifth Avenue sites for milUners' shops is limited, the demand 
for Fifth Avenue hats is very great, therefore Fifth Avenue 
hats have a high value, and Fifth Avenue sites for milliners' 
shops command a high rent. 

Artificial Scarcity and Rent. — In every case of rent which 
we have considered, the payment of rent is due to the limita- 
tion in quantity of the agent of production paid for. Fertile 
land pays a higher rent than infertile land because it is scarce 
relatively to the demand for it ; central position pays a high 
site-rent because in every town only a few sites are central; 
exceptional ability commands exceptional payment because 
exceptional ability is rare ; mourning goods, on the death 
of a member of the royal family, command a value far above 
their cost of production because they are scarce relatively 
to the suddenly increased demand for them. In all the cases 
we have considered so far, however, this scarcity relative to 
demand is due to nature, the distribution of population, or 
changes in demand ; the scarcity has been due to causes be- 



35© Economics for the General Reader 

yond the control of any individual. A definition of rent that 
would cover all the cases considered so far is, " Rent is the 
payment made for an agent of production which has a scarcity 
value due not to the owner or user of the agent, but to natural 
or social causes beyond any individual's control." Scarcity, 
however, may be artificial; the supply of a commodity or 
a service may be deliberately restricted when the supply can 
be controlled. When this is done, the commodity or service 
will acquire a scarcity value ; the capital and labor employed 
in supplying it will have produced an amount of value greater 
than that produced by the same amount of capital and labor 
employed in a market where suppliers compete and do not 
limit supply. Now " rent," Ricardo says, " is always the 
difference between the produce obtained by the employment 
of two equal quantities of capital and labor." Scarcity and 
monopoly values of all sorts, then, are akin to Ricardian rent. 
The motive of artificial limitations of the supply of anything 
is to secure on the capital and labor supplying it a higher 
return than could be obtained if the supply were not so limited. 
The test of Ricardian rent can be applied to scarcity and 
monopoly incomes ; the output of the capital and labor em- 
ployed in one of these monopolies is not proportionate to the 
payment for the product and will not be checked if the price 
falls ; it may even be increased, since at lower prices a larger 
output will be needed to secure the same total profit. A 
large part of profits, therefore, are similar in their nature to 
rent ; for, as we saw in Chapter XVIII, in modern business 
restrictions on competition play an important part in the 
creation of profits. 

Ill 

Social Implications of the Ricardian Theory of Rent 

Rent as a Stimulus to Production. — The social impor- 
tance of the Ricardian Theory of Rent should by this time 



Rent 



351 



be clear. It points us to a distinction in income between 
those elements which evoke and stimulate production and 
those which do not. The owners of the agents of production 
can get for the use of those agents payment in proportion 
to their productivity, and their productivity is all that con- 
cerns the entrepreneur who uses them. Society is concerned 
with the further question, how much of these payments affects 
productivity — to what extent is the output of the agents of 
production unaffected by the amount of payment? Ricardo 
showed that the productivity of land was largely independent 
of the"payment made for land ; we have seen that to a slighter 
degree the productivity of labor and capital is independent 
of payment ; to use Dr. Marshall's phrase, wages and profits 
as well as rent contain elements which are not part of " the 
necessary supply price " of labor and capital, that is to say, 
are not payments that society must keep up if it is not to 
check production. The distinction is of the utmost impor- 
tance in framing a general social policy. The poUcy of 
laissez-faire and the rigid maintenance of the so-called " Rights 
of Property" were based on the view that all payments evoked 
a response in production, and that competition kept the pay- 
ment of every agent and every individual that contributed 
to production somewhere near subsistence level. The Ricar- 
dian analysis of distribution indicates how large is the pro- 
portion of the flow of wealth which could be diverted from its 
present recipients without at all affecting the volume of the 
flow of wealth. The distinction he points us to, between 
income that does and income that does not evoke produc- 
tion, must be a deciding consideration in any judgment on 
the economy of the present economic organization as a whole. 
The "Single-Tax." — A practical use of the distinction 
can be made in taxation. Taxes may be regarded as the 
price paid for the services of the State ; they cannot, however, 
be charged to individual citizens in proportion to benefits 
received; the State therefore levies payment on the whole 



352 Economics for the General Reader 

community, on principles of practical convenience rather 
than of abstract justice. It is suggested that taxes should be 
concentrated on rent and the other elements of income similar 
to rent; the argument for this is that rents are payments 
for productive power which is not due to the efforts or sacrifices 
of the rent receiver, and which will not be affected by a reduc- 
tion in the payment. The followers of Henry George go 
further and advocate a single tax on the rent of land, on the 
ground that rents, not being the creation of any individual, 
should not be the property of any individual, but of the State. 
Objections. — In its extreme form there are grave objec- 
tions to this proposal. Though no individual may have 
created the rent-producing capacity of land by his labor, a 
great many individuals have paid for that capacity with the 
produce of their labor. Society has allowed rents to be 
treated as an ordinary investment; the State has given no 
warning that it regards the investment of $500 in land as in 
any way different from the investment of $500 in United 
States or Railway bonds, and to subject a man's income to 
a special tax, merely because he put his money into land in- 
stead of into government or Railway bonds, may be expedient 
and may even be necessary, but has no basis in justice. 
Further, rents are capitalized every time the property that 
yields them changes hands, and the present receivers of rents 
are frequently receiving only the current average rate of 
interest on their investment ; as we have seen all along, from 
the point of view of the individual investor there is no dis- 
tinction between rent, wages, and interest. Moreover, the 
rent of land, as the term is used in ordinary speech, is not all 
" economic rent " ; a large part of it is interest on capital 
embodied in permanent improvements of the land, and in 
practice it is extremely difi&cult, sometimes impossible, to 
distinguish between the two sources of a given income. 
Economic rent, again, is not confined to incomes from land ; 
wages, fees, and salaries, to some extent, and profits to a very 



Rent 353 

large extent, include elements indistinguishable in principle 
from Ricardo's rent. Finally, if taxes are the price paid for 
the State's services, it is doubtful whether it is wise to exempt 
from all payment any citizen who benefits by those services, 
as would be done if Heniy George's proposals were adopted ; 
taxes are the chief source of an interest in politics and the 
chief stimulus to a sense of political responsibility. 

Economic Rent and Fiscal Policy. — In spite of these 
difficulties in its application, the distinction between economic 
rent and other kinds of income is of importance to finance 
ministers. It must always be a principal aim of sound 
taxation to raise the money needed without checking the pro- 
duction of wealth, and this aim can be attained only by con- 
centrating new taxation on the rent elements of private 
income ; these elements are payments for productive powers 
which are not evoked by payment, and which therefore will 
not be checked by taxation ; the other elements are evoked 
by payment and will be checked by taxation. The least 
amount of interference with legitimate expectations is in- 
volved by appropriating rents in capitalized form by a tax 
on unearned increments and taxes on inheritance. Land is 
not the only form of property subject to unearned increment, 
just as land-rent is not the only form of income that con- 
tains an element of economic rent ; but, unfortunately for the 
owners of the land of a country at the time when the taxation 
of unearned increment is first introduced, land is the form of 
property on which unearned increment can be most easily 
detected, measured, and taxed. The profits of speculation 
on the Stock Exchange are just as much unearned as the 
increment in the value of urban building sites ; unhke the 
profits of speculation on produce markets, they represent 
no service to society ; and, in amount, they must be as great 
as the unearned increment on land ; but they are not so easy 
to " get at " as the unearned increment on land. As the re- 
quirements of the modern State grow, then we may expect 



354 Economics for the General Reader 

attempts to concentrate taxation more and more on economic 
rent of all forms, wherever it can be detected, and on the large 
incomes which, it may be presumed, contain the biggest 
element of economic rent. And the tendency is expedient, 
since it is the only way of raising additional taxation without 
checking the increase in wealth. If we take into considera- 
tion the existing inequalities of wealth, it has an additional 
justification, as tending in a slight degree to correct those 
inequalities ; the injustice of selecting one class of investments 
for heavier taxation than the rest may be added to the list of 
inconveniences which arise from the incessant conflict between 
the rights of private property and the interests of the com- 
munity. 



CHAPTER XXI 
THE STATE AND THE ECONOMIC ORGANIZATION 

I 

Private Property and Freedom of Enterprise 

The State and Economic Organization. — The economic 
organization that we have been studying is distinct from the 
political organization of society, and largely independent of 
it. Economic relations overstep political boundaries and 
have become world-wide, while States are relatively local; 
commerce is cosmopoUtan, while States are, roughly speaking, 
national. The economic organization achieved this independ- 
ence in spite of the efforts of States, which sought during the 
period of the Mercantile System to control the flow of trade 
and the distribution of labor and capital among different 
employments. Adam Smith's Wealth of Nations showed that 
the State, at any rate in the United Kingdom, had failed in 
this endeavor. The law hampered, but did not direct industry 
and commerce ; the organization of industry and exchange and 
the distribution of the product were settled by contracts 
between individuals, and controlled by forces- other than the 
laws of Parhament and the executive powers of the Sovereign. 
To-day, as in Adam Smith's time, the State has only a sub- 
ordinate influence over the organization of production and the 
distribution of wealth. The organization is much the same 
in countries in which the form of State varies, and we have been 
able to study the economic organization so far without tak- 
ing account of the political organization. While, however, 

355 



356 Economics for the General Reader 

economic and political organizations are distinct, there is 
nothing in the nature of either of them to prevent the State 
from undertaking economic operations. While economic 
organization and political organization are largely independent 
of each other, the degree of their independence varies from 
time to time and from State to State, and is never complete ; 
the two react on each other, and wide differences of opinion 
exist as to the proper relation between them. It is necessary 
therefore to consider, however briefly, what are the relations 
between the State and the economic organization to-day, and 
to examine the poUcy of which the existing arrangement is 
the expression. 

The Nineteenth Century View. — During the nineteenth 
century the view of the relation of the State to economic 
organization that had most influence was the view that they 
should be as distinct and independent as possible. The 
obsolete and hurtful character of the State-regulation exist- 
ing at the beginning of the century discredited State-regulation 
as such; Adam Smith had shown that the organization of 
industry and commerce was a spontaneous thing, owing Httle 
or nothing to the direct action of the State, and that it had 
in it a sort of self -regulating principle, which made it un- 
necessary for the State to interfere in the pubHc interest. 
This self -regulating principle is the action of competition. 
A belief in its beneficent effects ^ was the mainspring of the 
movement to " free " industry and commerce from all State 
" interference," and is the ground of most opposition to 
State-regulation to-day. Although an elaborate system of 
laws and administrative machinery regulates industry to-day 
— the movement in the first half of the century for the 
abolition of the obsolete system of State-regulation having 
been succeeded in the second half by a movement to impose 

^"All systems either of preference or restraint, therefore, being thus com- 
pletely taken away, the obvious and simple system of natural liberty establishes 
itself of its own accord." — Wealth of Nations, Bk. IV. ch. ix. 



The State and the Economic Organization 357 

new regulations adapted to the new conditions of industry — 
society still relies on competition, rather than on direct 
State action, to secure harmony between private and public 
interests. The organization of production is on the whole 
effected by free contracts between individuals, the dis- 
tribution of the product is left by the State to be determined 
by the bargaining of the individuals who directly or indirectly 
take part in production. 

The Present Social System. — The present social system in 
regard to economic activities is based on two institutions, 
property and freedom of enterprise. By the institution of 
property (or private wealth) society allows a person the 
exclusive use and control, and even the disposition after death, 
of any wealth that person may acquire ; by freedom of enter- 
prise society allows a person to seek wealth in any way that 
person chooses. There are limits both to the rights of prop- 
erty and to freedom of enterprise embodied in the law ; the 
more obvious forms of theft and violence are excluded from 
freedom of enterprise, and taxation is an obvious encroach- 
ment on the exclusive control of wealth by individuals. Still, 
the portion of the economic field over which property rights 
and freedom of enterprise do not operate is small in comparison 
with the portion over which they do operate ; the presumption 
in the case of any form of wealth is always that some owner 
has the absolute control of it, the presumption in the case 
of any trade is always that any individual is free to enter it. 
The nature of these institutions is brought out by a com- 
parison with medieval society, in which the idea that any 
individual should have exclusive control of land or freedom 
to enter any trade or occupation he liked would have been 
thought ridiculous. Property, that is, the exclusive use 
of wealth, is the prize offered by society to induce individuals 
to compete in producing wealth; freedom of enterprise is 
the device on which society relies to insure that no one shall 
acquire wealth without competition. 



358 Economics for the General Reader 

Contract. — The economic organization is built up by the 
free enterprise of individuals seeking wealth. Each is free — 
so far as the State is concerned, and with certain exceptions 
to be mentioned later — to apply his labor or his land or his 
capital to any branch of production and in any way he thinks 
best ; each is left by society to get in return, by bargaining, 
without interference of the State, what share he can of the 
product. Economic relations depend, according to the theory 
of the present organization, not on status but on contract. 
The State may lay down conditions, which must be compHed 
with before it wiU enforce any contract, and some contracts, 
such as a gambling debt, it may refuse to enforce at all; 
but it does not ordain what shall be produced or who shall 
produce, nor does it decide how the product shall be divided ; 
it does not as a rule fix prices or wages, the rate of interest 
or the amount of rent, and only in exceptional cases does it 
directly organize production. 

Market-value as the General Guide. — The indicator that 
production follows, the guide that tells individuals to what 
purposes to apply their labor or their capital or their land, is 
market value. Value, we have seen, depends on the relation 
of supply to demand. When the value of a thing goes up, it 
indicates either that the demand has increased, or that the 
supply has fallen off, and in either case that more is wanted ; 
the higher value offers to producers higher remuneration, 
and it is assumed that under a system of free enterprise in- 
dividuals can be relied on to increase the supply. When 
the value of a thing falls, it indicates either that the demand 
has fallen off or that the supply is in excess, in either case 
that less is wanted ; it is assumed that the fall in value will 
warn people to apply their productive powers to other objects 
and so check the supply. Society — since normally it makes 
no other provision for directing its productive forces — ■ 
assumes that value is an adequate indicator of wants, and that 
with this automatic indicator nothing further is required to 



The State and the Economic Organization 359 

secure the most economic application of productive forces to 
need. 

Regulatory Effect of Competition. — For regulation of 
production and distribution in the public interest, society 
relies on competition. We have already examined competition 
in Chapter VI. We saw there that it works in two directions. 
Trades, firms, and individuals compete to sell their product or 
the productive powers of their land, labor, or capital ; they 
compete for custom, which means for a share of the wealth of 
society in exchange for what they have to offer. Similarly 
individuals, firms, and trades compete to buy; they compete 
with one another in offering of their wealth for the finished 
or partly finished products of industry or the productive 
powers of land, labor, and capital. The competition to sell 
tends to keep down prices, and also wages, interest, and rent, 
which are the price paid for the services of labor, capital, 
and land ; it tends to force prices down to cost of production, 
and this effect of competition is the chief influence on which 
society relies to protect the consumer against exploitation. 
The competition to buy tends to force prices and wages, 
interest, and rent up ; and this effect of competition is the 
influence on which society relies to secure fair treatment of 
the producer and a just distribution between different kinds 
of producers and between the different agents of production. 
If any trade or class of producers is getting more than it 
ought, the high value of its product is expected, under the 
system of free enterprise, to attract competition, which will 
force it to accept less ; if any is getting less than it ought, the 
low value of its product is rehed on to check production, divert 
labor and capital elsewhere, and so force up the value of the 
product and the remuneration derived from it. All are 
compelled by the fear that their competitors will undersell 
them constantly to adopt the latest methods and equipment. 
At the same time an incentive to make experiments and dis- 
cover improved methods exists in the higher margin of 



360 Economics for the General Reader 

profits which the innovator draws in the interval between 
the first application of the new method, while prices are at 
their old level, and its general adoption, when the reduced 
cost of production all round brings prices down. In the 
long run, however, competition gives the benefit of improved 
methods to the consumer in the form of reduced prices ; and 
since competition to sell is usually stronger than competition 
to buy, the free play allowed by society to competition works 
on the whole in the interest of the public as consumers rather 
than as producers. Because society normally relies in this 
way on competition for regulation of production and dis- 
tribution, the phrase " the present competitive system " is a 
just description of the present economic organization. 

II 

Regulation and Supersession of Freedom of Enterprise by the 

State 

State Interference and the Producer. — Experience, how- 
ever, has shown that society cannot, without bad results, 
leave production and distribution entirely to the regulating 
influence of competition. There has been a steady growth of 
State interference with industry ever since the doctrine of 
noninterference was first promulgated. In the early factories 
competition, coupled with the defenseless condition of the 
workers, tended to make the worst conditions of employment 
into the standard conditions. The abandonment of sanitary 
conditions, hours of work, speed of work, exposure to risk 
of accident from machinery, and the age of the workers to the 
regulation of competition, made hells of mines and factories, 
and compelled the State to interfere in defiance of any economic 
principles ; conditions in domestic workshops were probably 
just as bad, but the evils were not so obvious and the Govern- 
ment of the United Kingdom dealt with social evils not when 



The State and the Economic Organization 361 

they became acute, but only when they achieved notoriety. 
Hence arose Factory Legislation, " that first conscious and 
methodical reaction of society against the spontaneously 
developed form of the process of production," as Marx calls 
it. Conditions of employment are now regulated by the 
State in innumerable ways ; the contract of employment has 
become a " conditioned " contract, a contract, that is to say, 
which the State will not recognize and enforce, unless it 
complies with certain conditions laid down in statutes — as 
to sanitation, ventilation, fencing of machinery, hours of 
work, age of the workers, and in some cases medical inspection, 
and even wages. This interference by the State does not 
supersede private enterprise, and does not abolish competition ; 
it merely places limits on the freedom of private enterprise 
and imposes some limiting conditions on competition. The 
difference between the unregulated factory industry of the 
early nineteenth century and the regulated industry of to-day 
is the same as the difference between a fight in the street and 
a fight in the ring under Queensberry rules. 

State Interference and the Consumer. — Just as the State 
has been forced to interfere with freedom of enterprise and 
regulate or supplement competition in the interest of pro- 
ducers, so it has been forced to interfere on behalf of consumers. 
Normally society leaves the quality of commodities to be 
maintained by competition, the theory being that consumers 
will exercise a sound judgment and purchase the products of 
those firms that give the best quality at a given price. In 
practice consumers do not always exercise this judgment ; 
they consider price rather than quality, often they have not 
the knowledge needed to judge quality, and the effect of 
competition is at least as often to beat quality down as to 
maintain it and reduce price. The State has therefore imposed 
a sort of minimum quality in the case of certain services. 
Freedom of enterprise in the medical and legal professions is 
restricted, and those only are allowed to practice who have 



362 Economics for the General Reader 

satisfied the conditions as to training, etc., laid down by the 
professional associations to whom the State has intrusted this 
regulation. In adopting this method of securing the regulation 
of the professions and the quality of the services, the modern 
state is imitating the mediaeval municipality, which used 
the same device with the same object, by intrusting the 
regulation of the crafts to privileged guilds. In the case of 
the chief articles of food the State has regulated their sale by 
Pure Food Laws, and inspects them to see that they are fit 
for consumption and that they are what they profess to be. 
The inspection of weights and measures is a similar " inter- 
ference " to protect the consumer. The restriction of the 
sale of alcohoHc drinks to individuals specially licensed has a 
slightly different motive; it is not intended to secure the 
quality of the drink, so much as to insure the collection of 
revenue and to restrict the scope of the sale of intoxicants. 

The Tariff. — The interferences with freedom of enterprise 
which we have examined so far have been based partly on 
economic grounds, partly on grounds of morality or general 
social advantage. The wholesale interference which Protection, 
using the word in its special sense as the opposite of Free 
Trade, involves is justified partly on economic and partly on 
political grounds. Statesmen have felt dissatisfied with 
the cosmopolitan tendencies of commerce, and have sought 
to make commerce national by protective tariffs ; in the United 
Ivingdom, where such a tariff does not exist, the movement to 
create one derives a large part of its force from the desire 
to make the economic organization of society in the British 
Empire correspond with and support its political organization. 
The more usual ground of protection is, however, not political 
but economic ; it consists in a disbelief in the necessary identity 
of private and public interests in economic matters, and a 
belief in the necessity of positive control by the State, instead 
of the automatic control afforded by competition. 

State Interference with Monopoly. — There are, however, 



The State and the Economic Organization 363 

an increasing number of cases in which the State has found 
itself forced to depart from its usual rule and to supersede 
private enterprise altogether. One case is monopoly. There 
are certain industries, which we examined in Chapter VII, 
in which efficiency can be secured only by monopoly. In such 
cases the State cannot rely on competition to regulate private 
enterprise, since competition is technically undesirable if not 
impossible. Either, therefore, the State has to devise very 
stringent control of private enterprise, or to supersede private 
enterprise altogether ; the tendency, as we saw, is for the 
State to supersede private enterprise, since only in that way 
can it be sure of complete control. PubHc utility services, 
railways, and postal and telegraph organizations between 
them represent a considerable proportion of the world's 
productive capacity; they all tend to be taken over and 
worked by the State instead of being left to private enter- 
prise. If the tendency of the State, national and local, to 
become a large land-owner for similar reasons, be taken into 
account also, it will be seen that the exceptions to private 
enterprise are becoming almost as important as the rule. 
And this revolution is being achieved, not by any abrogation 
of the rights of property, but simply by the State acquiring 
this property by the ordinary method of purchase, usually 
with the proceeds of a loan. The State is a legal person, 
just like any individual or corporation, and can acquire 
property and exercise enterprise just like any other legal 
person. Although the State has taken over only technical 
or natural monopolies, the Trusts have given the State an 
important object lesson in the waste of divided control in 
competitive industry, and the economy of centralized control. 
Education. — A second case in which private enterprise 
has been superseded by State enterprise is the case of certain 
services, now among the ordinary functions of government 
but formerly left to private enterprise, of which education 
will serve as the type. Within the last two generations the 



364 Economics for the General Reader 

State has made itself responsible for most kinds of education. 
It was forced to take this step, because education, though 
socially desirable, is not a thing that people are very willing 
to pay for. Even the schools of the rich cannot always pay 
their way, and have to appeal to the charitable public, like any 
vicar of a slum parish, for aid in the form of endowments. If 
every one received no more education than he or his parents 
were willing to pay for in an unsubsidized market, few would 
learn more than the three R's. Education is a service which 
will not be forthcoming in the quantity and quality that are 
socially desirable, if society relies on the system of free enter- 
prise regulated by competition. Sanitation and highways 
have similarly been taken over by the State from private enter- 
prise. The care of sickness is on the border-line, the State 
having made itself responsible for the treatment of infectious 
diseases, while it leaves others, except for subsidies, under 
Compensation Acts, to be dealt with by private enterprise 
and charity. 

State Aid to Charity, etc. — Charity, or " voluntary effort," 
is a sort of compromise between private enterprise and State- 
action. When a want of obvious social importance is left 
unsatisfied by private enterprise — because the people who 
suffer the want cannot afford to pay for the satisfaction of it — 
charity will step in and mitigate the unwillingness of the State 
to secure the social well-being. Such voluntary organization 
is a departure from the principles of the " competitive system," 
just as much as is State-action ; considerations of expediency 
and convenience rather than considerations of principle deter- 
mine whether a community shall act in these cases through 
voluntary organizations or through the State. A complete 
list of the services, which it does not pay private enterprise 
to offer and which have therefore to be provided either by 
charitable gifts or by the State, would be a long one and 
would include some of the most important of services. 
Education, as we have seen, belongs to this class. So does 



The State and the Economic Organization 365 

research. Universities would be in a poor way if they had 
to depend on the payment made for their services by those 
students who hold no scholarship or other subsidy. The 
Churches would not be much better off. Art does struggle 
along, thanks to the social convention that requires the very 
rich to exhibit a portion of their riches on their walls ; but 
artists have terrible competition to face in the pictures of their 
dead predecessors, the Old Masters, especially in America. 
Left to the ordinary laws of supply and demand, the cult of 
beauty, the pursuit of knowledge, and the service of religion — 
perhaps one should say religious organizations — would all 
languish. 

Ill 

Taxation 

Finally there are those services, the ordinary functions of 
government, that have never been left to private enterprise. 
The State exists because individuals living together in a society 
want services which can be provided only by the organization 
we call the State. They want laws to delimit their rights and 
a sovereign to enforce those laws, to maintain order, and to 
defend the State against attack from outside. Existing for 
these fundamental purposes, the State proves to be the most 
convenient organization for supplying many other services, 
so that it is impossible to set any hard and fast limit to the 
functions of the State. Now the services of the State, what- 
ever they may be, cost something to provide, and have to be 
paid for ; taxes are the price we pay for the services of govern- 
ment. Government services differ from other services, first be- 
cause they cannot as a rule be measured and allocated to indi- 
viduals ; secondly, because we are compelled to accept them 
whatever the charge made. Hence governments cannot as a 
rule charge individual prices or fees proportioned to the benefit 
conferred, and they are not subject to the check on incom- 



366 . Economics for the General Reader 

petence and extravagance that attends private enterprise 
in loss of custom and eventual bankruptcy ; the individual 
(if he is wise) decides what he will spend by the amount of 
his income, governments decide what they will spend first, 
and then fix their income to suit. To deal with the second 
difficulty and provide a check on extravagance, representative 
control of public finance has been devised ; to deal with the 
first and secure a just allocation of the charges of government, 
principles of taxation are needed. 

Characteristics of Good Tax-system. — Principles of taxa- 
tion have been classified under two heads, Administrative 
Precepts and Political Principles. Under the first head come 
certain requirements of Government. Government requires 
a tax-system first of all to be productive; hence a finance 
minister will be very reluctant to relinquish on any grounds 
of political principle a tax to which people have become 
accustomed and which brings in a large income to the Treas- 
ury; and, on the other hand, he will be willing to forgo 
small receipts that take a great deal of collecting. Secondly, 
it requires a tax-system to be certain; the yield must be 
easily calculated and the incidence certain and reliable, or 
the intentions of the Government will be frustrated. Thirdly, 
it requires a tax-system to be elastic; the system should 
contain some taxes, the rate of which can be readily varied 
to meet sudden and exceptional demands for Government 
expenditure. Under the same head of administrative precepts 
come certain requirements of the tax-payer. The first is 
again certainty; the payer should know exactly how much, 
when, and where he will have to pay. Uncertainty is a check 
upon industry, and it makes the burden of taxation more 
grievous, since an unexpected burden cannot be anticipated 
and provided against like a certain one. Secondly, the payer 
requires a tax to be economical; i.e. it should take from the 
tax-payer's pocket as little as possible over and above what 
it brings into the treasury. Protective duties are uneconom- 



The State and the Economic Organization 367 

ical, since the consumer has to pay an enhanced price, not 
only on imported articles which are taxed, but also on home- 
manufactured articles which are not taxed. Thirdly, the 
payer requires convenience in a tax; a tax should be levied 
at the time and in the manner most convenient to the payer. 
The advantage of the system of raising revenue by indirect 
taxes on luxuries is that it leaves the payer free to some extent 
to choose the time and amount of taxation he will pay. Of 
these administrative precepts certainty is the most important. 
Society can adjust itself to almost any burden if the burden 
is definite ; any uncertainty prevents this process of adjust- 
ment. Hence the saying " An old tax is no tax," and hence 
the known reluctance of finance-ministers to remit an old tax, 
however logical such action might seem. 

Political Requirements. — Of the poHtical principles, on 
which a tax system should be based, the most important is 
the principle of justice or equality. Unfortunately it is not 
agreed in what justice or equaHty consists. One interpretation 
that suggests itself is taxation according to benefit; but the 
benefit that accrues to any individual from the State cannot 
be measured. Another is that taxation should be propor- 
tional to income ; this was suggested by Adam Smith, who 
said, " The subjects of every State ought to contribute towards 
the support of the Government as nearly as possible in pro- 
portion to their respective abilities, i.e. in proportion to the 
revenue which they enjoy under the protection of the State." 
Ability to pay, however, is not, as Adam Smith assumed, 
proportional to income. Taxation proportional to income 
would mean inequality of sacrifice, since, in accordance with 
the principle of diminishing utility, a tenth part of a small 
income represents a much greater satisfaction than a tenth 
part of the larger income. Hence progressive taxation is 
proposed ; a tax system which takes an increasing propor- 
tion of income as the income gets larger would secure some- 
thing like equality of sacrifice. Another interpretation of 



368 Economics for the General Reader 

justice in taxation is faculty, or ability to pay, a compromise 
between proportional and progressive taxation; so far as 
there is any principle in existing tax systems, it is probably 
the principle of " faculty." 

Necessity for Compromise. — Whatever interpretation be 
put on the principle of justice in taxation, it would probably 
be regarded as impractical and visionary to base a tax system 
exclusively upon that principle. Hence finance ministers are 
urged to have regard also to the effect of the tax system on the 
flow of wealth. The ultimate source of all revenue is the 
national income, and from the purely economic standpoint a 
tax system should be so devised as not to reduce the national 
income or check its growth ; taxes should be levied where 
they will not reduce efficiency. This end can be achieved 
by taxing rents, and we have already discussed the principle 
in Chapter XIX. These " principles of taxation " are in- 
definite and often conflicting. The best tax system must 
be a compromise between them; existing tax systems are 
based on no principle, and can be understood only by ref- 
erence to the historical circumstances under which they 
grew up. 

To sum up: society has departed very widely from the 
strict rule of noninterference with industry by the State; 
indeed, the policy of noninterference was never carried out 
logically by any State. In the United Kingdom the beginnings 
of Factory Legislation, the type of the new State interference, 
were established in the practice of the State before the Corn 
Laws, the type of the old interference, were repealed. In the 
United States the doctrine of noninterference never got a 
strong foothold. While, however. State interference is 
general, the direct supersession of private enterprise by State 
action is still the exception. If we ask for a brief description 
of the present social system in its economic aspect, " com- 
petitive " is still the best we can find ; if we look for a rule or 
principle on which the system is founded, we find it still in 



The State and the Economic Organization 369 

the separation of economic organization from political organi- 
zation. As a rule and in the main, society still relies for the 
organization of its economic activities on private enterprise, 
with private property for incentive and competition as 
regulator. 



CHAPTER XXII 

THE STATE AND THE ECONOMIC ORGANIZATION 

(Continued) 



The Assumptions of the Present System 

The attitude of society to the economic organization, 
which we studied in the last chapter, is subjected to a large 
amount of criticism. This criticism is usually combined 
with and dependent on the propaganda of some alternative 
system or policy, and as such falls outside the scope of this 
book, which has for its object merely the elucidation of the 
present system and not the advocacy of some alternative 
system. The present system, however, although it is the 
outcome less of the application of principles to the problem 
of social control over the economic organization than of the 
general neglect of the problem by statesmen, makes certain 
general assumptions, on which it depends for justification ; 
and it falls within the scope of our scheme to bring these 
assumptions into the light and examine them. The assump- 
tions seem to be four in number. 

The Adequacy of Self-interest. — The first is that individuals 
in their economic relations can be relied on to pursue their 
own interest, and that their action will be rational and 
informed. It is only on that assumption that consumers can 
be expected to seek out and give their custom to the producers 
who can satisfy them best, to play off competing producers 

370 



The State and the Economic Organization 371 

against one another and so keep prices down towards cost of 
production; it is only on that assumption that producers 
can be expected to bargain and secure the full value of their 
services. 

Competition and Survival. — The second is that competition 
in industry will result in the survival of the socially fittest. 
No one denies that competition produces hardships for in- 
dividuals ; such hardship is justified only if competition secures 
for society the elimination from industry of incompetent or 
dishonest entrepreneurs and the survival of the fittest. 

Property and Service. — The third assumption is the mosV 
important and may be put thus : that as a rule private wealth 
or property will be acquired only by service and, conversely, 
that services will be induced by the possibility of acquiring 
private wealth, so that it will be the private interest of some 
one to supply every service in which there is a public interest. 
Only on this assumption is society justified in leaving the 
distribution of wealth, a social product, to be settled by 
private contracts between individuals; only on this assump- 
tion is society right to restrict the activities of the State, 
and to lay the onus probandi on the advocates, instead of on 
the opponents, of any extension of the State's activities. 

Market Values and Social Values. — The fourth assumption 
is that market values correspond roughly with social values, 
and are an adequate indicator of need for production to follow. 
We must conclude that value is regarded as an adequate 
indicator of need, since the greater part of production is left 
to follow that indicator ; if the value of a thing goes up, more 
labor, capital, and land will be applied to producing it ; if its 
value goes down, less will usually be produced. 

Like most of the principles on which statesmen act (or 
more usually refuse to take action) and citizens vote, these 
assumptions are largely unconscious and seldom formulated. 



372 Economics for the General Reader 

II 

The Assumption of Rational Self-interest 

That the first assumption, if true at all, is subject to 
exceptions, has been recognized by society. Pure Food Laws 
have been passed, because purchasers do not always scrutinize 
carefully the goods they purchase, and Acts to compel the 
fencing of machinery have been found necessary, because 
workers are sometimes so irrational as to take unnecessary 
risks. The exceptions, however, are much wider than the 
State has recognized, and the principles on which existing 
restrictions on freedom of enterprise have been based would 
justify much more extensive restrictions. 

Controlling the Consumer. — If purchasers were always 
rational in their actions, producers would be able to secure 
their custom only by offering a better article at the same price 
as their competitors, or by offering the same article at a lower 
price. In practice these are not the only methods adopted to 
secure custom. Consumers are open to be influenced, their 
action is not always rational, and it is not at all unusual for a 
firm to spend as much in selUng its product as in making it. 
The expenditure on advertising in the United States was 
estimated a few years ago at $600,000,000 a year. The object 
of it is to induce consumers to purchase commodities, whidi, 
if left to themselves, they would not purchase. Advertising 
is only one method of inducing purchasers to buy, when 
on purely rational grounds they would not buy ; the employ- 
ment of travelers, expenditure on surface finish and fancy 
wrappings, the constant introduction of novelties that have 
absolutely nothing but their novelty to recommend them 
are all examples of the great waste of productive capacity which 
the irrationality of purchasers invites. Competition con- 
stantly tends to increase it, since if one firm in a trade adopts 
an advertising device all competing firms must follow suit; 



The State and the Economic Organization 373 

the result is that all draw level again in competing power, 
while so much effort that might have gone to reduce cost of 
production and prices is wasted, so far as the consumer is 
concerned. The inertia which leads people to buy from the 
nearest shop, or from the shop they have always bought from ; 
the feeling of friendship which leads firms and individuals to 
maintain economic relations, even when more advantageous 
terms might be obtained elsewhere ; the ignorance that makes 
consumers eager to purchase anything for which a fashion can 
be created ; all these go to show that the self-interest of 
consumers is as little to be relied on as their reason. At the 
most, we can only say that competition among sellers will 
tend to protect consumers against exploitation ; custom, 
ignorance, and the persuasive arts of salesman and advertiser 
will often prevent the tendency from becoming a fact. Com- 
petition will tend to work in the consumer's interest, but 
producers spend large sums in getting control of the consumer. 
Modification of Self-interest. — Even less true is it to 
assume that producers will be actuated in economic affairs 
exclusively by motives of material self-interest. The use of 
land and the expenditure of capital on land in England have 
for two centuries at least been influenced by political and social, 
as well as by economic considerations ; good agricultural land 
has been turned into parks, and landlords have made it a 
practice to remit in bad seasons a portion of the rent due to 
them. Investors in investing their capital are not un- 
influenced by fashion, skillful advertisement, philanthropy 
(as in the case of model tenement houses), and even patriotism. 
Business men are influenced by friendship and their conception 
of what is " fair " in business. Least of all, workmen act 
from a reasoned consideration of their material interests. 
Their choice of occupation is largely a matter of chance — 
the State is only now attempting to devise machinery to insure 
a wise choice of employment by the young. They rarely 
press for the most they could get when trade is booming; 



374 Economics for the General Reader 

strikes would be many times as frequent as they are if the 
manual working class made it the chief object of their Ufe 
to get as much as they could out of industry. ! 

This first assumption of the " competitive system " takes 
an unduly narrow view of human nature. The pressure of 
competition would be intolerable if every one in his economic 
relations always insisted on his full pound of flesh. So far 
as individuals are actuated solely by motives of material 
self-interest, industry does tend to become intolerable, as it 
is in the underpaid sweated industries on the East side of 
New York and the overpaid sweated industries of Pittsburg. 
Fortunately, human beings as a rule remain human in their 
economic relations ; they are influenced by other than com- 
mercial motives. By relying on material self-interest for the 
driving force of industry, however, society encourages a wild 
pursuit of wealth ; it penalizes the man (or class) that does not 
care about money-getting, and it tends to put wealth under the 
control of the greedy and unscrupulous. 

Ill 

The Assumption that Competition leads to the Survival of the 

Fittest 

How far can the second assumption be granted? How 
far is competition in industry a struggle leading to the survival 
of the fittest? It is often regarded as such. People with 
wealth complacently regard themselves as on that account 
" fitter " than the poor, and therefore entitled to their greater 
riches ; possession of riches they take as both evidence and 
reward of " fitness." 

Importance of Equality. — It is clear that the struggle 
can have the effect of selecting the fittest only if the com- 
petitors start level. The competitive system, in relying on 
competition to secure a just distribution of wealth, treats 



The State and the Economic Organization 375 

free competition as equivalent to equal competition ; private 
property makes it impossible that free competition should be 
equal. Most of the competitors are handicapped by lack of 
property, which means defective training and lack of capital. 
Hence for most people freedom of enterprise is an empty 
privilege ; they may be " free " to enter any trade or pro- 
fession that offers a high remuneration, but they have not the 
means. On the other hand, the few who have property re- 
ceive a start in the race, and can choose and continue in an 
occupation, irrespective of their ability, so long as their prop- 
erty lasts. An increasing number of people are exempt by 
the accident of birth from the struggle for survival, and it is 
very largely from their ranks that the individuals are drawn 
who control industry and govern the country. Freedom of 
enterprise is often confused with equahty of opportunity. 
Freedom of enterprise obtains ; but it is ineffective either to 
secure in every case the fittest for positions of direction 
and influence, or to eliminate the unfit from such positions, 
because equahty of opportunity does not exist. Freedom 
of enterprise is a partial check on incompetence or " un- 
fitness," and it enables the exceptionally able or industrious 
or fortunate to rise to positions of importance, as the exist- 
ence of the " self-made man " shows. Its estabHshment has 
resulted in great increase in wealth, testifying to a great 
improvement in the organization of production ; but it 
cannot be relied on, in the existing inequaHty of opportunity, 
to secure a distribution of the product in proportion to abihty 
and industry. While there is too much competition in some 
quarters, there is not enough in others. 

Character of Fitness. — Assuming, however, that economic 
competition is a struggle tending to the survival of the 
" fittest," the question arises, " Fittest for what? " So far 
as the test afforded by the struggle is efifective, it is a test 
only of fitness to make wealth. The argument is a justification 
of free competition, only if the end of man is the production of 



376 Economics for the General Reader 

material wealth. The distinctive feature of man is that he is a 
moral being ; he can choose his end, and judge his " fitness " 
by reference to that end. To justify free competition on 
the ground that it gives position and influence to the " fittest " 
is therefore to choose the production of material wealth as 
the chief end of man. If any other end be chosen, for in- 
stance art, the reUgious life or the service of others, then free 
competition will stand condemned, because the survivors of 
the economic struggle are not conspicuous for love of beauty, 
piety, or disinterested philanthropy. A St. Francis or a 
Stevenson (not Stephenson) survives by reason of his very 
unfitness to make money; the cathedrals of the thirteenth 
century are a great achievement just because their builders 
did not adopt the methods that bring wealth in a competitive 
society. " Efficiency " is often used in the same loose way as 
" fitness." Just as the rapid acquisition of wealth, if due to 
causes other than luck, proves fitness to acquire wealth, which 
may carry with it unfitness to do anything else (especially to 
spend it well), so a high degree of efficiency may denote a low 
grade of ability and character, if the work is mechanical and 
requires httle initiative and originality. Stevenson's " effi- 
ciency " at writing did not enable him to earn enough to keep 
himself until he was over thirty, while the " efficiency " that 
earns a popular novelist thousands a year will often fail to 
keep his writings alive ten years after he is dead. The 
type of " efficiency " or " fitness " that the competitive 
system tends to throw up is the *' self-made man " or the 
American millionaire; he is sometimes a very admirable 
person, but sometimes one is reminded of Sydney Smith's 
reply to a man's boast that he was "self-made" — "You 
take a great responsibiHty off the shoulders of the Almighty." 



The State and the Economic Organization 377 

IV 

The Assumption that Wealth Will Be Associated with Social 

Seroice 

The third assumption is the most important ; it is the 
most general ground on which production is left to private 
enterprise and distribution to private contracts. The assumf>- 
tion is of course only that, as a rule, private wealth is the 
reward of service and that, as a rule, services will be induced 
by the prospect of private wealth. Exceptions to the rule are 
admitted by the practice of States, and we have already noted 
the chief of these exceptions ; what we have still to note is 
that the grounds on which these exceptions were made would 
justify other exceptions so numerous and important as to sug- 
gest doubts of the validity of the rule. If it be found that the 
system of free enterprise admits in its normal working of pri- 
vate wealth without service, then the presumption against State 
interference with production and distribution breaks down. 

Effect of Combination. — The chief case in which the State 
has superseded private enterprise on the ground that private 
enterprise would allow individuals to exact payment out of 
proportion to service, and so acquire private wealth without 
service, is the case of technical monopolies. When monopoly 
is required by technical considerations, as in the case of most 
public utilities, the consumer loses his usual protection against 
exploitation, namely competition, and the State has to devise 
other safeguards. Any restriction of competition, however, 
even if it fall far short of complete monopoly, deprives the 
consumer of his safeguard, competition ; and restrictions on 
competition are far more frequent than perfectly free com- 
petition. In allowing freedom of enterprise society assumes 
that it will always pay producers to supply society with what 
it wants in the largest quantity possible ; a very little 
experience of the effects of competition teaches producers 



378 Economics for the General Reader 

that it may pay them better to restrict competition and 
limit supply. By limiting supply they force values up, 
and high values on a limited output may pay them as well 
as a limited output at a low value. The interest of society 
lies in a large output and low values, the interest of pro- 
ducers lies in high values, and if they can secure high values 
by no other means they will contrive to limit output. There 
is therefore in the system of free enterprise, since free enter- 
prise includes freedom to combine as well as freedom to com- 
pete, a principle encouraging producers to make a profit out of 
society's loss ; they can make society pay them more by the 
simple process of giving society less. 

Under Conditions of Controlled Demand. — Nor is it safe 
to assume that freedom of enterprise will insure that producers 
will apply themselves to producing the things that people 
want. Consimiers are open to influence ; on the whole they 
are not averse to being told what they want, so that they are 
saved the trouble of deciding for themselves. Hence it is 
possible for producers, by advertisement and other means, 
to control demand, and make a profit by supplying what 
nobody, who stopped to think, would want. Thus pills that 
cost a penny a box to make and can have no effect on any 
disease except by way of faith-cure are sold at 25 cents a 
box ; and countless products, made only to sell, earn for their 
manufacturers profits which represent no social service. 
Even when the advertised cormnodity is good of its kind, as 
are many proprietary foods, and the receipts of the businesses 
supplying them do not much more than cover expenses, the 
payments made by society are out of all proportion to the 
service received by society ; for a large part of the expenses 
of the businesses consist of the expenses of advertisement 
and selling. All the cases we examined in which society 
assumed rational conduct and self-interest without justifica- 
tion are cases in which wealth will be obtained by some one 
without a corresponding service to society. 



The State and the Economic Organization 379 

Other Exceptions. — When we examined the function of 
the dealer, we found that there were certain kinds of deahng, 
which we called " illegitimate speculation," which profited 
individuals at the expense of society. It is not necessary to 
recapitulate them ; here v/e need only note that they tell 
against the assumption that wealth is obtained by service, 
and in the aggregate they form an important part of modern 
business. In most modern communities, owing to the growth 
of population and the increase of wealth, one kind of trans- 
action akin to dealing affords especial opportunities of 
growing rich without performing any equivalent service to 
society. There are certain forms of wealth of which the supply 
is limited : Old Masters are the most obvious and land the 
most important example. As population grows and wealth 
increases, the demand for such things grows, and the fortunate 
possessors of them grow steadily richer without lifting a finger. 
The continued influence of the older aristocracy in the United 
Kingdom is due largely to this source of private wealth. It 
should be as difficult by sitting still to add a peimy to one's 
income as it is by taking thought to add a cubit to one's 
stature. 

Inheritance. — The older aristocracy suggests another and 
the most important method of acquiring wealth without 
rendering service, namely inheritance. It is no merit in a 
man to be born the son of a millionaire ; yet society rewards 
his judicious choice of parents more highly than it rewards 
the efforts of its greatest artists, philosophers, scientists, and 
inventors. The inheritance of wealth is as important a 
cause of inequalities of wealth as is free enterprise ; it has 
not the same grounds of social expedience. Even if private 
wealth is found to be the best incentive to wealth production, 
freedom of testamentary disposition seems an unnecessary 
extension of its rights. In this respect Feudalism, with its 
close association of duties with property and its resumption 
of possession by the King whenever the duties attaching to 



380 Economics for the General Reader 

the property could not be performed by the tenant, affords 
a suggestive comparison with the modern system. To be 
logical, the advocates of free enterprise and competition should 
advocate the abolition of inheritance; the results of such a 
policy would be interesting and very different from the present 
system. 

Rent. — Of almost equal social importance with the cases 
of individuals obtaining without rendering service are the 
cases in which wealth is indeed obtained in return for a service, 
but for a service that would have been forthcoming even if 
no payment has been made — the cases, that is to say, in 
which the payment is of the nature of economic rent. Land 
gives a service for which society pays the landowner ; but land 
would be just as serviceable if no payment were made. We 
have seen that economic rent, or payments for productivity 
which is not evoked by or dependent on the payment, form a 
large part of income, not only of the income from land, but 
also, though in a less degree, of incomes from labor and capital. 
We saw also that society makes no distinction between 
economic rent and payments which do evoke, and are necessary 
to evoke, productivity; and no distinction between invest- 
ments in property that yields economic rent and investments 
in property that yields only interest. Any wholesale con- 
fiscation, therefore, of rents or rent-yielding property would 
disappoint the legitimate expectations of individuals ; it would 
involve injustice to these individuals and might create a 
feeling of insecurity that would outweigh the advantages of 
the confiscated property. While, however, the theory of rent 
does not justify a policy of confiscation, the consideration of 
economic rent remains of the utmost importance in forming a 
general view of the economic organization, since it is essential 
to a sound judgment of its advantages. It is an obvious 
defect of the present arrangement that society pays so much 
of its wealth to individuals, not indeed for nothing, but for 
services which it might have had without paying for them, if 



The State and the Economic Organization 381 

only it had not allowed them to get into private hands. The 
present arrangement is socially wasteful, since society spends 
so much of its income in appljdng its normal incentive to 
production — property or private wealth — where no in- 
centive is needed. A recognition of this waste is to be dis- 
cerned in the attempt to concentrate the new taxation needed 
to finance new State-services on large incomes, of which 
economic rent may be presumed to form a large part, and 
to buy up natural monopolies and land, to secure any in- 
creases in the rent they yield. 

Conclusion. — The assumption then that property rep- 
resents service to society is too large to fit the facts, and the 
cases in which society has recognized an exception by socializ- 
ing a service or taxing a form of income by no means exhaust 
the exceptions. Free enterprise must be the basis of any 
organization of industry, but its disadvantages have been 
underrated, and there is no adequate ground for the existing 
presumption against State-enterprise. Even when wealth 
is obtained in return for service, the service may be accom- 
panied and neutralized by some disservice ; the cheap goods 
of the sweater are a service, but a service neutralized by 
the social evil of sweating. This aspect of the present 
economic organization, however, can be considered better 
in a later chapter. 

Even less adequate does private enterprise appear when 
we consider the converse of the assumption we have been 
criticizing, namely, that ali the services society needs, and 
in the present state of wealth can afford, will be forthcoming 
from private enterprise. So numerous, we have seen, are the 
cases in which the State supplies services, formerly neglected 
or supplied by private enterprise, that the assumption would 
need no further criticism if it were not that there exists a 
widespread though unconscious feeling that a service is not 
important or worth providing, unless it will " pay " in a 
competitive market. This simple test of the need for a thing, 



382 Economics for the General Reader 

Will people pay for it? is doubtless useful and convenient as 
a rough-and-ready guide to production ; more than that it is 
not. To use it as a general test of the value of services is 
to assume a coincidence of public and private interests which 
does not exist for two reasons : firstly, because many people 
are too poor to pay for things which it is in the public interest 
that they should have, and secondly, because there are many 
services enjoyed communally, which individuals either will 
not or cannot pay for individually. In the first class fall the 
elementary functions of government. The administration of 
justice was at one time suppHed for fees and paid for by fees ; 
society found it " pay " better to supply it " at a loss." 
General elementary education is needed in the interests of 
society, but cannot be paid for by those who benefit by it. 
Sanitation and the treatment of infectious diseases the State 
has taken over from private enterprise ; for the same reason, 
namely, that health is a public interest, it is assuming responsi- 
biHty for the treatment of other diseases and for the feeding of 
school children. Decent housing accommodation cannot be 
supplied commercially to certain classes ; and apparently land 
for small farmers is not to be had at a price they can pay ; in 
both cases the State is interfering. In the second class fall 
such amenities of town life as parks, picture-galleries, and 
museums. Individual workmen in congested districts cannot 
afford open spaces, the town provides them ; individual students 
of art cannot afford to buy good pictures, the State buys for 
them, — it is true that the taste shown by the State in its 
purchases is not always the best possible, but the taste of the 
State is the average of the taste of the citizens, and that can be 
raised only by a more generous expenditure on art. Liberal 
studies and research do not " pay " commercially ; the State 
therefore contributes to their upkeep, and ought to contribute 
more. Street-railways may justly be run " at a loss," if they 
help to relieve overcrowding or are needed to maintain the 
prosperity of an agricultural district. Services supplied by 



The State and the Economic Organization 383 

the State " at a loss " are merely services paid for partially by 
taxes instead of by prices ; the maintenance of law and order 
and national defense are paid for wholly by taxes, yet no one 
speaks of them as being " run at a loss." Utility to a com- 
munity is one thing, utility to individuals another. Where 
individual values and social values coincide, the supply of 
services can be left to private enterprise ; where, as in so many 
cases, they do not coincide, the State, or some other public 
body, must act. In the case of government enterprise a 
commercial loss may be a social gain. 



The Assumption that Market Value Is a Satisfactory Indicator 
for Production to Follow 

The last assumption of the present economic system is that 
market value is not only an automatic indicator for production 
to follow, but an ideal indicator, which we have only to follow 
to secure the greatest possible amount of satisfaction for 
society from the efforts and sacrifices of production. A high 
value indicates that a thing is wanted much, it also stimulates 
the supply of it, falHng value indicates that no more of a thing 
is wanted and at the same time checks the supply of it ; so 
that, it is assumed, we have only to leave business men to 
follow market values in their production and society will get 
just what it wants. According to this view, given free com- 
petition, supply and demand tend to reach an equilibrium, 
at which the efforts and sacrifices which lie behind supply 
are exactly balanced by the satisfactions which lie behind 
demand ; thus present values represent a maximum economy 
of the application of means to ends, a maximum of satis- 
factions and a minimum of cost. 

Influence of Unequal Incomes. — Such a conclusion 
requires not merely free but equal competition. The in- 



384 Economics for the General Reader 

dicator value, though it is as a matter of fact followed by 
production, is very unreliable as a guide to the best use of the 
productive powers of society. Let us return for a moment 
to our examination of the influence of utility on value. We 
saw that the law of diminishing utility explains our valuations 
of things. The value we put on anything depends on the 
amount of it we have, every addition to our supply of it 
gives us less satisfaction than the previous addition ; therefore 
the falling of the value of a thing as the supply increases does 
indicate that it is satisfying a less intense want, and, by 
indicating to the producer that something else is not wanted, 
does conduce to a greater total of satisfaction. But this 
explanation tells us only why different quantities of the same 
commodity give different degrees of satisfaction to the same 
person ; why, in the instance we took, a third pound of tea a 
week gives less satisfaction than the first pound of tea; it 
does not tell us why different individuals set different valuations 
on the same quantity of the same commodity, why, for instance 
the man with $5000 a year values one pound of tea at $1.25 
and a second at 75 cents, while the man with only $500 values 
one pound of tea a week at 50 cents and a second pound at 
25 cents. The reason is of course that their incomes are differ- 
ent. The actual valuation that a man sets on a pound of tea 
a week depends not only on the number of pounds he has 
already, but on the income out of which he has to satisfy 
all his wants. 

Illustration. — Suppose we had a " unit of satisfaction," 
suppose satisfactions could be measured and we could express 
any satisfaction in terms of that unit ; then we should find that 
five dollars represented to the man with $50,000 a year the 
possibility of, say, one unit of satisfaction, to the man with 
$5000 a year something like ten units, and to the man with a 
wife and children to keep on $15 a week perhaps a hundred 
units of satisfaction. Spent by a rich man five dollars gives 
one unit of satisfaction, spent by a poor man five dollars 



The State and the Economic Organization 385 

gives a hundred times as much satisfaction ; therefore the 
rich man to get the satisfaction of a pound of tea a week 
might be willing to give $50, while the poor man, for the 
same satisfaction, would only give 50 cents. The rich man, 
since his chief wants are all near the point of satiety, will 
spend in satisfying his slightest whims as much money as 
the poor man will spend to satisfy his greatest needs. The 
reason is the same law of diminishing utility ; the rich man can 
carry the satisfaction of his wants further than the poor man, 
and therefore gains less from an additional purchase. 

Now in the market the rich man's five dollars, which rep- 
resents one unit of satisfaction, has exactly the same influence 
as the poor man's five dollars, which represents a hundred 
units of satisfaction. If a rich man offers $500 for a Pekinese 
puppy while a poor man is offering $495 for the education of 
his children, the productive resources of society under com- 
petitive conditions will be devoted to getting the rich man 
his Pekinese puppy before the education of the poor man's 
children will be thought of. This is so only if the proportion 
that costs of production bear to market value is roughly the 
same with the different services ; but as a matter of fact we 
may expect the margin of profit to be greater in the case of 
commodities consumed chiefly by the rich, since rich buyers 
have not the same incentive as poor buyers to beat prices 
down. The richer classes will have the first claim on the 
productive resources of society because money means least 
to them ; as their luxuries pall and their whims are exhausted, 
they will offer less and less for further satisfactions, the value 
of their luxuries will sink, until it pays producers better to 
satisfy the needs of the poor; by following market values 
producers supply the extravagant futilities of Palm Beach, 
while food, decent housing and clothing are lacking in the 
slums. 

Inadequacy of Market Value as Social Guide. — In follow- 
ing market values, then, the organizers of production are 



386 Economics for the General Reader 

following a blind guide, so far as the social value of work is 
concerned. Market values would indicate where the pro- 
ductive powers of society can be applied to produce the greatest 
satisfaction only if incomes were equal or proportionate to 
families. The unequal distribution of wealth makes them a 
false and misleading indicator, and the greater the inequality of 
wealth the greater will be the waste due to this faulty appli- 
cation of the productive powers of society. InequaKty of 
wealth is increasing, great fortunes are like snowballs; we 
may expect therefore a less and less economical application 
of productive power to wants as time goes on, we have to 
look to a growing divergence between the aims of production 
and the needs of society. Society is behaving like a man who 
should spend $200 on a dress suit when he has no under- 
clothing, or buy fancy cakes when he needs bread. Market 
values are the outcome of the present distribution of wealth ; 
the principle on which they, and therefore the economic 
organization of which they are the center, are based is the 
principle " Unto him that hath shall be given, and from him 
that hath not shall be taken away even that which he hath." 
This characteristic of market values makes the present 
distribution of income, as weU as the direction of production, 
unreasonable. We saw that productivity was an important 
influence in distribution; competition among entrepreneurs 
tended to secure for each producer and each agent of pro- 
duction the equivalent of its productivity. But " pro- 
ductivity " is always productivity of value, and therefore 
bears no necessary relation to need. The product of Milton's 
labors from 1658 to 1665 was Paradise Lost, the productivity 
of those labors was between $50 and $100, the price he re- 
ceived for the product. The produce of a farm is usually 
increased by keeping game down, but by stocking the farm 
with game at the expense of the produce the productivity 
will often be increased, since more will be paid altogether 
for the use of the land. The defense, then, of the present 



The State and the Economic Organization 387 

distribution of income that it is in accordance with pro- 
ductivity, that each gets the value of his contribution to wealth, 
is an explanation merely, not a defense. Value is a question- 
begging term. All that this argument amounts to is that 
the contribution of each is valued at what he gets. If we inquire, 
Have these values any basis in principle, any constant 
relation to social service, any absolute standard? we find 
that they have not. 

Difficulties Involved To-day. — In conclusion, it may be 
noted that the policy of laissez-faire^ which dominated the 
State in English-speaking countries during a large part of 
the nineteenth century, created enormous difficulties for the 
State in the twentieth century. It was natural enough and 
doubtless expedient to sweep away a system of State-regula- 
tion of economic activities which had been rendered obsolete 
by the Industrial Revolution. But the evils of State-regula- 
tion in the early nineteenth century were due to the character 
of the regulation and of the State, not to State-regulation as 
such. And the State, having once reHnquished the attempt 
to control the economic organization, has found the task of 
control doubly difficult since it has resumed the attempt. 
The very success of the policy of laissez-faire in stimulating 
the growth of material wealth has complicated the task, since 
it has created great fortunes and businesses, that can meet 
the State on terms of something like equality. Economic 
relations have in some places become of more importance 
than political relations ; the economic organization, which 
always develops more rapidly than the political organization, 
threatens to swamp or control the State. Hence the strong 
reaction against laissez-faire; hence the regulation of con- 
ditions and hours of employment, the proposal in Great 
Britain to return to Protection, the State-fixing of wages, and, 
in some cases, of rates and prices, the proposal to extend to 
England from Scotland and Ireland the State-fixing of rents, 
the municipalization of public utiUties, the dissolution of 



388 Economics for the General Reader 

trusts — though trusts are a perfectly natural outcome of 
free enterprise, — the taxation of the overrich. Yet the 
State has not got control of the economic organization; 
in many places the economic organization controls the 
State ; and there are signs, in such movements as Syndicalism, 
of a despair of the State as a means of securing the social 
control of the economic organization, which will increase still 
further the difficulty of securing State control. Moreover, 
the reluctance of nineteenth-century governments to regulate 
and supplement freedom of enterprise has resulted in evils 
that obscure the importance of freedom of enterprise itself. 
Freedom of enterprise in some form or another must be the 
basis of any organization of production based on specialization ; 
not only is it the only effective guarantee of individual 
initiative, and therefore of elasticity and adaptabiUty in the 
organization, but the alternative — that the State should 
decide in detail what every one shall do and what every one 
shall receive — is a task to which no body of officials is equal. 
But freedom of enterprise does not exclude State enterprise, 
and the existing presumption against any interference with 
freedom of enterprise is the most serious hindrance to true 
economic progress. 



CHAPTER XXIII 

WEALTH AND WELFARE — THE MEASUREMENT OF 
WEALTH 



Wealth as Product 

Definition of " Wealth." — The word "wealth" is used 
in more senses than one. The commonest seems to be 
" economic wealth," which, we have seen, means anything 
that satisfies a human want and is not unlimited in quantity. 
Economists take this meaning of the word and standardize it. 
Economics is the study of the social organization by which 
wealth in this sense is produced and distributed. The want 
which a thing must satisfy, to come under this definition of 
wealth, may be of any kind. The beer with which the 
drunkard tries to satisfy himself is just as much wealth as 
the beer that the temperate take to quench their thirst on a 
hot day. Rifles and bicycles, made sometimes by the same 
firms, are both wealth, though their uses are so different. 
" Bad " Uterature and " bad " art are wealth just as much as 
" good " literature and " good " art, since many people get 
a satisfaction from them ; those who possess them are rich 
to the extent to which they possess them ; if they get no satis- 
faction from them themselves, they can sell them to people 
who do, and with the proceeds buy something that they do 
want. While the want which a thing satisfies may be of 
any kind, the thing must be limited in quantity, or it will not 

389 



39© Economics for the General Reader 

count as wealth. If it is unlimited in quantity the possessors 
of it will be unable to exchange it for anything else, since no 
one will give anything in exchange for a thing that can be had 
for nothing. This differentia is necessary to the definition of 
wealth, since the word is applied — strictly within its original 
meaning, but only metaphorically to-day — to things which 
satisfy human want and are unlimited in quantity. Fresh 
air, for example, and scenery are spoken of as wealth. In the 
ordinary sense of the word, however, they are not wealth ; 
no one who had more of them at his command than he wanted 
could get anything in exchange for them ; only when the 
supply of them is limited do they become wealth in the 
narrower and more usual sense of the word, as they would do 
if the fresh air were laid on to New York by pipe from the 
Adirondacks, or the scenery inclosed ia a park and a charge 
made for admission. 

Wealth as the Object of Economic Organization. — This 
narrow use of the word " wealth " identifies wealth with the 
product of the economic organization. The economic or- 
ganization as a whole exists to produce means of satisfying 
wants that are not unlimited in quantity or provided " free " 
by nature ; means of satisfaction, that is to say, which will 
not be forthcoming without some organization to produce 
them. The organization and its parts derive their value 
from the product ; the worker gets a wage only because his 
work is needed to produce these means of satisfaction; a 
machine has a value only because it can be used for the same 
purpose ; the product is the end and object of the organiza- 
tion. The wealth of an individual or a country is the means 
of satisfaction which he or it possesses, or, in other words, the 
amount of the product of industry and commerce which he 
or it can command. The product usually takes a material 
form'— so many pieces of cloth, so many tons of coal, etc, ; 
but it may equally well take the form of a service. Transport 
is an important part of the wealth of modern countries; it 



Wealth and Welfare — The Measurement of Wealth 391 

satisfies wants, directly and indirectly, and it is not provided 
by nature free. The services of the professions are wealth of 
the same kind. Indeed, material goods are desired only for 
the services which they render ; men want not cloth but 
clothing, not coal but heat, and cloth and coal are wealth only 
because they enable men to satisfy these wants. But whether 
we speak of goods and services or of services alone as forming 
the content of wealth, we identify wealth with the product 
of the economic organization ; the economic organization 
exists to produce these means of satisfying wants, and but 
for the' economic organization they would not be forth- 
coming. 

Measuring Wealth. — The method by which wealth is 
measured brings out clearly this conception of it. It is always 
assumed that wealth is m.easurable, and it seems only a matter 
of time and trouble to total up the wealth of a country in tons 
of this commodity, yards of that, and gallons of another. 
Such a method, however, would give us no measure of wealth 
in the form of services ; we might put in our inventory so 
many surgeons and so many teachers ; but since the surgeons 
and teachers might differ very much in their abiUty, skill, 
and industry, we should have no measure of the country's 
means of satisfying its wants in the way of surgical treat- 
ment and education. And even in the case of material forms 
of wealth such a measure is inadequate, since it ignores dif- 
ferences in quality ; sixty yards of one kind of cloth may be 
double the amount of wealth embodied in sixty yards of an- 
other kind of cloth. The difficulty is overcome by totaling 
not the forms of wealth themselves, but their exchange-values. 
Most production is carried on for exchange, and nearly all 
forms of wealth are at some time or other exchanged. This 
exchange takes place not directly, but through the medium of 
money. Hence money becomes a general common measure 
of exchange- values, and a total of wealth is expressed in terms 
of money ; so accustomed have we become to measuring 



392 Economics for the General Reader 

wealth in money, that the word " money " is frequently used 
as synonymous with " wealth." 

Practical Difficulties in Measuring Wealth. — There are, 
however, practical difficulties in the way of getting directly 
the total value of the product of the economic organization, 
since in no country is anything like a complete annual census 
of production taken. Indirectly, however, the total can be 
reached by adding together incomes, which we have the 
means of estimating. A man's income is the claim (meas- 
ured in money) which he has on the product of the economic 
organization ; the total of the incomes of the people in the 
country will be the total value of the country's product, 
since the claims as a whole are exchanged for the product as 
a whole. We have more information about people's incomes 
than we have about their capital or total wealth, and, as we 
saw in Chapter XII, we must consider wealth as income 
rather than as stock, if we are not to overlook certain im- 
portant forms of wealth, especially services rendered directly 
and not through the medium of commodities. 

By making a total of incomes the wealth of the United 
States is estimated (191 8) at about sixty billion dollars a year. 
The information about incomes is, of course, very inexact. It 
is estimated that not more then 6,250,000 people will file a 
return under the present law. Wage statistics are fragmen- 
tary and unreliable, but careful statisticians have prepared 
estimates on the basis of such data as is available. Sixty 
billions under present conditions (19 18) is therefore approxi- 
mately, if not absolutely, accurate. This total of incomes is the 
total value of the annual product of the country's economic 
organization; for the incomes are simply the claims on the 
product which the economic organization gives rise to. The 
method of measuring wealth, then, and the estimate of the 
wealth of the country as a whole, are based on the conception 
of wealth as consisting in product. 

There is no need to go behind this conception for the purpose 



Wealth and Welfare — The Measurement of Wealth 393 

of studying the organization for producing and distributing 
wealth. Economics, in standardizing this meaning of wealth, 
is merely following ordinary usage. A *' rich " man is a man 
with a large command of the product of the economic organiza- 
tion, whether he exercises iu by buying goods or services. A 
" rich " country is a country which derives a large amount of 
product from its economic organization, or has large claims 
on the product of other countries' economic organization — 
as England has in the form of interest on foreign investments. 
The present age is " rich " compared with earlier ages, be- 
cause the product of its economic organization is so much 
greater ; when we speak of the " growth of wealth " we mean 
the increase of product. On this conception of wealth the 
present economic organization is based. It is directed solely 
to securing the largest possible product in proportion to ex- 
penditure, and is judged accordingly. Distribution is based 
on the assumption that those who contribute to production 
can be relied on to insist on a proportionate share of the 
product ; they are " efficient " in proportion to their pro- 
ductivity, and the system is " fair " or " unfair " according as 
distribution is in proportion to productivity. 

II 

Wealth as Welfare 

But the word " wealth " is capable of another meaning. 
It is used to denote anything that contributes to human wel- 
fare. In this sense, wealth will not exclude any means of 
satisfying human wants merely because they are not limited 
in quantity ; in this sense, fresh air and scenery are an im- 
portant part of wealth. On the other hand, it does discrimi- 
nate between wants, and excludes from the category of wealth 
the means of satisfying some wants which do not contribute 
to welfare. What satisfactions we regard as contributing 



394 Economics for the General Reader 

to welfare depends on our ethical views ; but even the Utili- 
tarian, who regards satisfactions quantitatively only and 
makes pleasure the end of life, will hold that welfare requires 
some wants to be left unsatisfied (those that " draw repenting 
after "), while others need cultivation. 

Different Conceptions of Welfare. — There is not the same 
agreement in the application of the word " wealth " in this 
second sense as in the other sense. It is applied to different 
things according as conceptions of welfare vary ; the drunkard 
will apply it to beer, his wife probably will not. And concep- 
tions of welfare vary widely. The statesman who is anxious 
to pursue a " spirited " foreign policy regards armaments as 
wealth in this second sense of contributing to welfare, as well 
as in the other, more ordinary, sense ; the Quakers regard 
armaments as what Ruskin called " illth." Ruskin's quarrel 
with his contemporaries — or one of his quarrels — was that 
they regarded as contributing to welfare, and therefore as 
" wealth " in this deeper sense, the great mass of mechanically 
ornamented products of modern history, which he regarded 
as ugly, useless, and demoraHzing. The English governing 
class of a hundred years ago encouraged inclosures, partly 
because it was to their private interest so to do, but partly 
also because inclosures increased the product of the land, and 
they thought that an increase in product must necessarily 
bring an increase in welfare ; in Germany the same change 
was effected under a different conception of social welfare, the 
peasants on the land being treated as of more importance 
than the product of the land. 

Because there are these divergent conceptions of welfare, 
var5dng with every variation in ethical, aesthetic, and political 
views, economists have chosen to leave on one side the study 
of wealth in this second sense, and have confined themselves 
to wealth in the commoner, agreed sense ; they have studied 
the organization for satisfying wants, without considering 
distinctions in the kind of wants. Unfortunately, the two 



Wealth and Welfare — The Measurement of Wealth 395 

senses of the word are not kept distinct in ordinar}- speech. 
It is impossible in practice to prevent the associations attached 
to wealth in its wider sense from attaching themselves to the 
word when it is used to mean only economic wealth. The 
distinction can be made and maintained in a systematic 
treatise ; but as soon as we pass from the treatise to con- 
versation or public discussion, from study to practice, our 
careful distinction is likely to be ignored and perhaps for- 
gotten by ourselves. It is impossible, therefore, to make 
any practical use of economic studies, to apply the conclusions 
of economic science, without considering what is the relation 
between wealth in the narrower sense of economic wealth and 
wealth in the wider sense which includes all means of welfare ; 
we must have a clear idea of the relation of wealth — for the 
rest of this chapter we will keep the word to mean economic 
wealth — to welfare. It is the more necessary to consider 
this question, since wealth can be measured and changes in 
its quantity stated definitely, while of welfare there is no exact 
or definite measure ; inevitably, in the absence of any other 
measure of welfare, the economic measure will be used, and 
an increase in wealth treated as an increase in welfare. To 
state fully the relation of wealth to welfare would, of course, 
involve answering the question, What is welfare? and com- 
paring and criticizing all the divergent conceptions of welfare, 
which would be an ethical inquiry and beyond our scope. 
Our purpose, however, will be served if we can indicate the 
chief influences on welfare which the measure of wealth ignores, 
and so make clear the limits within which an increase of wealth 
indicates an increase of welfare. That is the important 
practical question ; how far, and under what circumstances, 
an increase of wealth is an increase of welfare. 



396 Economics for the General Reader 

III 

Defects in the Usual Method of Computing the Country's 

Wealth 

The wealth of the United States is estimated at about sixty 
billion dollars per annum. But such an estimate has serious 
defects ; it excludes much that is wealth and includes much 
that is not wealth. 

Goods and Services not Entering Exchange. — It excludes 
much that is wealth, because it takes account only of goods 
and services that come within the circle of exchange. There 
are many services given for which no payment is made, but 
which are wealth just as much as services which are paid for. 
The most important of these unpaid services is the domestic 
work of wives and daughters. Domestic servants are paid 
wages, hence their services are included in the estimate of the 
country's wealth ; wives and daughters are paid nothing for 
exactly the same services, hence no record or measure of their 
work exists, and their services are ignored in estimating the 
country's wealth. The services of Congressmen are counted as 
part of the country's wealth, since they receive a salary. The 
humbler, but equally useful, county commissioner or town 
councilman may be paid nothing for his services, which are 
therefore ignored in the process of computing the nation's 
wealth. The same is the case with all voluntary social and 
pubUc service, it is ignored in the ordinary computation of 
wealth ; yet the economic loss of a war would hardly be greater 
than the cessation of such services. The method ignores ma- 
terial forms of wealth as well as services. The vegetables a 
man buys are included in the sixty billion dollars per year ; the 
vegetables he grows for his own use will not be, since they do 
not come into the market, where wealth is measured by being 
exchanged for money. This element of subsistence economy 
is more important in America than in the United Kingdom, 



Wealth and Welfare — The Measurement of Wealth 397 

and used to be more important than it is ; as it gives place to 
commercial economy, the amount of wealth measured will 
increase, but there may be no increase in the product of the 
country's activities and resources. Of course it would be 
possible to estimate the value of these uncommercial goods 
and services, and add it to the estimate of the country's wealth 
obtained by the other method ; but the calculation would be 
difficult, there are no materials for it in existence, it is not, as 
a matter of fact, made, and the wealth it represents, remaining 
unvalued, tends to be overlooked. 

The Inclusion of Non-wealth. — On the other hand, the 
ordinary computation of a country's wealth includes much 
that is not wealth. It includes every form of money income 
which is received by the individuals in the country ; there 
are, however, sources of income to individuals which are not 
wealth from the point of view of the community. The Na- 
tional Debt will serve as an example. United States bonds 
are property, not wealth. The interest on them is not in the 
same category as the interest paid on industrial investments 
or on loans made to Municipal Corporations for industrial 
purposes ; the interest on the latter is produced by the plant 
in which the investment is embodied, it is an actual addition 
to wealth, which the investors are able to secure ; the interest 
on the former is merely a transfer of so much wealth from the 
taxpayer to the holder of government bonds, since the loan 
which the bonds represent has been spent once for all on war 
or some other purpose long ago, and is doing nothing to in- 
crease production now. 

Offsets. — More important than this source of error is the 
defect in the method of computing wealth, by which certain 
services are treated as additions to wealth which should really 
be treated as deductions from it. Coal is wealth, and the 
salaries, profits, and wages to which its production gives rise 
are rightly included in the estimate of the country's wealth. 
But the use of coal produces so much dirt in the atmosphere 



398 Economics for the General Reader 

that clothes need washing more frequently than they would 
do but for its use. A large part, therefore, of the expense of 
laundry should be set against the use of coal. The services 
of the laundries are not an addition to the wealth of the 
country; they are part of the cost of securing the addition 
to the wealth of the country made by the use of coaL We 
should deduct them from the value of the coal to get the net 
or real addition to the wealth of the country made by coal ; the 
ordinary computation adds them. There are many cases in 
which one industry or service is called for by the ill effects of 
others, many cases in which one group of workers merely re- 
pairs evils incidental to the work of another set, with the 
result that the net addition made to wealth is far less than the 
apparent addition. 

The increase in wealth produced by the factory system is 
subject to large discounts on this account. By bringing 
together the workers in large masses, the system enormously 
increased the productivity of labor ; but by bringing them 
together it at the same time created the modern town. Life in 
a town, to be healthy and decent, requires a much greater 
expenditure per head of population, on sanitation, street- 
paving and cleansing, police, and even education, than life in 
the country, as is shown by the higher level of local taxation 
in town than country. To estimate the net addition made to 
wealth by modern methods of production, therefore, we must 
deduct from the value of the product the expense of all these 
public utiUty services ; they are all part of the social cost of 
production of goods made by these methods. The ordinary 
computation of national wealth again does not deduct, but 
adds ; for it includes in the national income both the incomes 
derived from industry and the incomes derived from loans to 
establish these services and payments to maintain them. 
Factory inspection, wages boards, the trade union organ- 
ization which the workers have been forced to establish in 
self-defense, are all part of the social cost of production of 



Wealth and Welfare — The Measurement of Wealth 399 

goods made by modern methods, and should be debited 
against the goods. Similarly, if we wish to ascertain the 
real addition to wealth made by the motor industry, we shall 
have to deduct from the value of the motors the cost of recon- 
structing roads to suit motor traffic. Modem society is rather 
like an incompetent housewife, who " makes work " for herself 
by her slovenly methods ; with this difference that she com- 
plains of the extra work, while we glory in it, boasting of the 
increase of wealth and the unprecedented dimensions of the 
national income. 

Inadequacy of Market- value as Measure. — Another de- 
fect in the measurement of wealth arises from the fact that 
the only objective measure of wealth is market- value. Wealth 
is wealth because it satisfies human want ; an increase of 
wealth should mean, therefore, an increase of satisfaction; 
an increase of wealth as measured may take place without 
any increase in satisfaction. Our study of value has already 
revealed this to us. The value of a thing may change without 
any change in the thing itself. Restriction of supply or in- 
crease in demand will enhance the value of a thing without any 
increase in the satisfaction afforded, and demand depends on 
the distribution of purchasing power as well as on desire. 
The Degas, which the artist sold for $100 and one of our 
millionaires subsequently bought for $85,000, had the same 
capacity to satisfy human want at the lower value as at the 
higher. The satisfaction which an opera singer's services 
give the nation will remain the same, whether he be paid 
$100,000 a year or a legal maximum of $2500 a year ; but in 
the latter case the national income as measured will be $97,500 
less. The amount of satisfaction afforded to the nation by the 
unfortunate individuals employed as flunkeys would be in- 
creased if they were set to farm-laboring ; since flunkeys are 
paid higher wages than farm-laborers, the national wealth 
as measured would be reduced by the change. Market-value 
is not an absolute measure of satisfaction; it measures the 



400 Economics for the General Reader 

satisfaction afforded by different things to the same individual, 
it is no measure of satisfaction as between different individuals. 
The rich man's dollar has the same influence on market- values 
as the poor man's dollar, it represents a much smaller satis- 
faction ; hence a box at the theater has the same value, and 
represents the same amount of wealth as measured as several 
bushels of wheat. The unequal distribution of wealth makes 
market- values inevitably and progressively false as a measure 
or indication of the satisfaction afforded by wealth ; to meas- 
ure national wealth, therefore, by totaUng market-values is 
to get no measure of the satisfaction afforded to the nation by 
wealth. If the national wealth as measured were doubled, 
it would be no proof of a doubling of satisfaction. It would 
be possible and useful to draw up different inventories of 
goods and services, having all the same total value, but yield- 
ing different totals of satisfaction. In fact market-value, the 
only objective measure of wealth we have, is so very rough and 
fluctuating a measure of satisfaction, that it is no measure 
of wealth from the point of view of society at all ; and it is 
misleading to place so much reliance as is placed upon it in 
the study of wealth. 

If we are to measure national wealth by totaling means 
of satisfaction, we need a unit of satisfaction, a thing which 
we do not possess. At most, therefore, sixty billions a year 
is a rough measure of the nation's economic power; not of 
its product, but of its productive capacity ; not of the means 
of satisfactions afforded by the economic organization, 
but of the command of them afforded by the economic or- 
ganization. The amount of satisfaction that the nation will 
derive from its economic organization will depend, not only 
on the degree of productive power, but on its direction ; not 
on the volume only of the product, but on its nature ; not on 
the amount of wealth as measured only, but on its use. 



CHAPTER XXIV 

WEALTH AND WELFARE — ECONOMIC INFLUENCES ON 

WELFARE 



The Influence of Distribution 

Welfare and Inequality in Distribution. — We have to con- 
sider the influences exercised on welfare by wealth and ignored 
by the ordinary measurement of wealth. First the influence 
exerted by different uses of wealth. We can consider this 
influence under two heads : use by society, and use by the 
individuals who compose society. Use by society is the 
problem of distribution ; and distribution is conditioned to a 
large extent by the needs of production. The system of free 
enterprise is upheld as the best means of maintaining and in- 
creasing the production of wealth ; if free enterprise involves 
an unequal distribution of wealth, that inequality is condoned 
as providing the best incentive to enterprise. With the 
system of free enterprise as a productive organization we have 
dealt elsewhere ; here it is necessary to consider only the in- 
fluence of the inequality of wealth, which it involves, on the 
amount of satisfaction afforded by wealth. The unequal 
distribution makes market-values a false and misleading 
indicator of the satisfaction afforded by different kinds of 
wealth ; yet market-values are the sole indicator of the needs 
of society, followed by producers under the system of free 
enterprise. Free enterprise, therefore, following market- 

2n 401 



402 Economics for the General Reader 

values, is an automatic device for securing an uneconomical 
application of productive power, and preventing a maximum 
of satisfaction from being secured for a minimum of effort 
and sacrifice. Anything that tends to equalize the distribu- 
tion of wealth tends to lessen the vagaries of the indicator 
which production follows, and tends to secure a more eco- 
nomical application of productive power to satisfying wants. 
Taxation and laws of inheritance that tend to equalize wealth 
may check the growth of wealth in gross, and yet increase 
welfare by increasing the satisfaction afforded by wealth; 
the super-tax, taken from the incomes of the rich and expended 
by old-age pensioners, will afford the latter a much greater 
amount of satisfaction than the former would have got from 
it ; the bushel of wheat on which the poor will spend a couple 
of dollars will afford a much greater satisfaction than the seat 
at a theater on which the rich man might have spent it. 

Significance of Social Standards. — Welfare is influenced 
by the distribution of wealth in another way. Once the 
primary needs of physical existence are met, expenditure is 
governed very largely by social standards. People choose a 
house in accordance not merely with the requirements of 
health, but with the standard of house accommodation of 
their class. They choose clothes which will not only insure 
warmth, but will also satisfy a certain standard of ostentation. 
They buy books, not tdf^read — the books they read they get 
from the circulating library — but to conform to certain 
standards of furnishing. And poverty consists as much in 
inability to live up to the standards of one's class as in actual 
lack of wealth. Shabby clothes are a source of unhappiness, 
not because they fail to keep one warm, but because they 
make the wearer disagreeably conspicuous ; if every one wore 
shabby clothes, as was the case in the Middle Ages, no one 
would object to wearing shabby clothes. Moreover, the 
standards of one class influence the standards of the class 
below, and so on through all the classes of society. A con- 



Wealth atid Welfare — Economic Influences on Welfare 403 

siderable part of the expenditure of every class, except the 
very richest and the very poorest, is governed, not by any 
rational judgment of what will give the truest satisfaction, 
but by the desire to do as other members of the class do ; and 
in all the intermediate classes there are people who feel poor, 
although they are not poor by any absolute standard. Now 
the concentration of wealth in the hands of a few enables 
that few to set a very high standard of expenditure, which 
influences the ideas of all the other classes. The riches of 
the rich intensify the poverty of the poor. Where wealth is 
less, but more evenly distributed, as in Denmark, equal satis- 
faction can be obtained from a smaller income ; every class in 
Denmark lives in a smaller house, has less furniture and 
probably fewer clothes, and spends less on amusements than 
the corresponding class in England, yet they certainly get 
no less satisfaction from wealth. Thus it is probable that the 
happiness that wealth gives depends as much on the dis- 
tribution as on the absolute amount of wealth. The present 
age is unhappy not because it is poor — it is richer than any 
preceding age — but because the inequalities of wealth, which 
have become obvious to the most careless, have no basis in 
ethical principle. There are philosophers who try to bring 
ethical ideas into accord with this inequality ; but the basis 
of most Western people's ethical ideas are to be found in 
Christianity and democracy, neither of which gives any 
countenance to the inequality. Not what he was, but what 
he thinks he might have and ought to have, determines a man's 
state of mind. Hence the worker of to-day is discontented, 
and derives not the slightest comfort from the knowledge 
that in any earlier age his real income would probably have 
been less than it is. 

Wealth and Social Power. — Another drawback to an un- 
equal distribution of wealth is the opportunities it gives of 
tyranny. Wealth under any circumstances is power, and 
when it takes the form of ownership of the means of production. 



404 Economics for the General Reader 

on which the manual worker is dependent for the opportunity 
of earning his livelihood, it is a dangerous power. The con- 
tempt into which the State is falling is due to the contrast 
between the political forms of democracy and the economic 
reality of oligarchy. A class of multi-millionaires is a stand- 
ing menace to the supremacy of the State ; and the experience 
of beneficiaries suggests that a well-meaning millionaire is 
an almost greater nuisance than his wicked brother. 

II 

The Influence of the Use of Wealth and the Kind of Product 

Wasting Wealth. — Welfare, then, can be increased by a 
better use of wealth by society, in the form of a better dis- 
tribution of it, as well as by an increase in the amount of 
wealth; the ordinary computation of wealth is concerned 
solely with the measurement of the latter, and ignores the 
former. Similarly it ignores the even more important in- 
fluence on welfare of the use of wealth by individuals. An 
increase of production obviously is no increase of welfare if 
the product is wasted. Waste in the sense of objectless de- 
struction of product is rare; but in a broad sense there is 
waste whenever wealth is applied to a use that gives less 
satisfaction than another use to which it could have been 
applied ; and waste in that sense is common. To prevent 
it, as much care would be needed in spending as in getting ; 
consumption would have to be organized as systematically 
as production ; and as much care exercised in the choice of 
people to direct the organization. No such care is taken, and 
in consequence much production adds nothing to welfare. 
A man will work hard and increase society's wealth by build- 
ing up an efficient business, and then waste the increase in 
maintaining his children in an idleness which they do not 
enjoy and which is not good for them. Workers are con- 



Wealth and Welfare — Economic Influences on Welfare 405 

stantly speeded up and industry made more productive ; the 
additional product is no addition to welfare if the employer's 
share goes in ostentatious luxury, and the workers are driven 
by exhaustion to spend their share in procuring excitement 
to relieve exhaustion. Often an increase of wealth merely 
cancels some existing means of welfare. An addition to 
wealth that takes the form of motors so speedy as to constitute 
a danger to life and a nuisance to the inoflfensive pedestrian or 
cyclist may take away from the pleasure of walking and cycling 
more than it adds to the pleasure of those who can afford 
motors ; a colliery that blackens a countryside adds to material 
wealth only by destroying an immaterial source of welfare. 

Fads and Fashions. — Two kinds of waste or misapplica- 
tion of wealth are especially important as influencing welfare 
without being indicated by the measure of wealth. The first 
is the application of production to objects which give an 
obvious and immediate satisfaction, to the neglect of objects 
that give a more lasting or intense, though less obvious, satis- 
faction. This is illustrated by the contrast between the 
valuations of the market and the valuations of the connoisseur. 
Good art gives not only a different satisfaction from bad art, 
but more satisfaction. A thing of beauty is literally " a joy 
forever," while last year's fashions are the abomination of 
this. Modern industry gives us more furniture, more metal 
work, more carpets, more wall coverings, and more " decora- 
tion " than handicraft ; yet the connoisseur, the man who 
has made it his business to understand these things, prefers 
the quality of the age of handicraft to the quantity of modern 
industry. The view of wealth which counts only product 
encourages methods of production which are adapted to 
quantity rather than quality ; and freedom of enterprise 
encourages the supply of those pleasures which offer gratifica- 
tion on the easiest terms. Poetry as a rule gives a more in- 
tense pleasure than prose fiction, but it asks a greater effort 
from the reader ; prose fiction has grown, therefore, while 



4o6 Economics for the General Reader 

poetry is the pleasure of the few. For the same reason bad 
fiction is produced in greater quantity than good fiction ; for 
the same reason the moving picture " drama," which asks 
of the observer an intellectual effort that could not task the 
most feeble minded, is displacing the novelette. 

Varied Character of Satisfaction. — In the second place, 
the measure of wealth would be no measure of welfare, even 
if it represented the true amount of satisfaction afforded by 
wealth, because it ignores differences in kind of satisfaction. 
The definition of wealth on which the measurement of wealth 
is based regards the kind of wants as indifferent, looking 
merely to the quantity of satisfaction given. Wealth in 
this sense is a measure of welfare only on the Utilitarian view 
of welfare, that it consists in the greatest possible surplus of 
pleasure over pain; it is only on this view that differences 
in kind of satisfaction can be ignored, and differences in 
quantity or intensity alone regarded. The amount or in- 
tensity of satisfaction offered by two forms of wealth may be 
equal; they will count equally in the computation of the 
country's wealth. Their contribution to welfare, on any 
except the Utilitarian view, need not be equal, since there 
may be a difference between them which we express by the 
terms " higher " and " lower." Many satisfactions are what 
is called " demoralizing," drunkenness for example : the 
means of obtaining them (provided they are not unlimited in 
quantity) count as wealth, and contribute to the total of 
national wealth ; to welfare they contribute nothing, but 
rather detract from it. Other satisfactions, without being 
bad in themselves, may interfere with higher satisfactions ; 
riches, for example, hamper a man's entry into the Elingdom 
of Heaven, and, on the view of welfare that attaches im- 
portance to the Kingdom of Heaven, are to be avoided ; or 
to take a more mundane example, comfort in modern cities 
can be carried to such extremes that health is impaired by 
want of exercise. 



Wealth and Welfare — Economic Influences on Welfare 407 

Conclusion. — Wealth then, as measured, is no criterion 
of welfare ; the direction of productive power is as important 
for welfare as its amount; an increase of wealth may take 
such a form that welfare is not increased. The increase of 
wealth since the Industrial Revolution includes much that 
no one would be the worse without. Much of it is merely 
means of ostentation, which adds to the satisfaction of those 
who outshine their fellows only so much as it detracts from the 
satisfaction of those who are outshone. Much of it takes 
the form of machine-made ornament, which is neither in- 
dividual nor organic to the object to which it is appHed, and 
adds nothing to its beauty. The furnishings and fabric of a 
modern house of almost any class are plastered over with 
such futilities — all those trifles that are neither beautiful 
nor useful, give no satisfaction three days after they are 
bought, and get in everybody's way ; while those who can 
afiford collect old furniture, and the only thing which cannot 
be got is simplicity. The most expensive process in the mak- 
ing of pottery is the mechanical addition of the mechanical 
ornament that drives people to collect old china. The 
national income is further swollen by a host of things " made 
to sell," which attract purchasers by their surface finish but 
are useless for their ostensible object, and by all sorts of 
expensive processes and devices for manufacturing shams. 
We have no measure of utihty except the meaningless measure 
of money, and very few standards ; hence no measurement 
can be made of the amount of this useless production ; but 
obviously it occupies no inconsiderable portion of the pro- 
ductive powers of the country. 



4o8 Economics for the General Reader 

III 

The Influence of Work 

Significance of Conditions of Work. — The ordinary meas- 
urement of wealth then gives us no reliable indication of the 
amount or value of the satisfaction afforded by wealth. It 
ignores another influence which the economic organization 
exerts upon welfare, by taking into consideration only the 
product of the economic organization and seeking to measure 
that alone. The conditions of production, work, in the 
widest meaning of the term, are as important for welfare as 
the product. Some sHght recognition of this is to be seen 
in the attitude of the State to industry ; a certain rninimum 
of sanitation, safety, and, in some cases, leisure, is imposed ; 
but the interpretation given to " conditions " is so restricted 
that it is hardly an exaggeration to say that their influence on 
welfare has been forgotten by society. 

Conditions Involved : Object. — The influence of work on 
welfare is exerted through many channels ; the chief are 
perhaps its object, the nature of its process, and the nature of 
its control. The principle that the object of work is important 
to the worker is recognized in reHef works. It is felt to be 
demoraHzing to set a man to useless work, merely to make 
him work ; his self-respect suffers if he is set to dig trenches 
for another man to fill. The same feeling underlies the use 
of such a word as " flunkey " as a term of abuse ; it is felt 
that the work of a flunkey is beneath the dignity of a man and 
must react on his character. If this feeling is sound, then the 
number of workers whose self-respect would suffer, if they 
realized what they were doing, must be very great ; for the 
weavers who weave plush, and dyers who dye it, for the 
flunkey's breeches, are as useless as the flimkey himself. 
Specialization, by making it more and more difl&cult to assign 
to its ultimate destination any piece of work, is breaking down 



Wealth and Welfare — Economic Influences on Welfare 409 

this discrimination between occupations in accordance with 
their object; the same firm may supply paper for Bibles 
and paper for letting contracts. At the same time specializa- 
tion, by distributing among a large number of workers the 
making of each single thing, takes out of work the handi- 
craftsman's interest in the thing made ; it is possible to take 
in the making of a pair of boots something of the artist's 
interest in the making of a picture ; it is difficult to take the 
same interest in the clicking of an upper to a sole. 

Process. — Object and process act and react on each other. 
An interesting object will be interesting to make ; while an 
interest in the making is likely to be reflected in the object. 
It is hard to find work in which the workman takes no interest 
at all ; but there are great variations in the intrinsic interest 
of work, and much work that has only a negligible interest. 
At one extreme is the work of the artist, an activity so satisfy- 
ing that it is claimed (by the advocates of art for art's sake) 
that the consumer of the product need not be considered ; 
at the other extreme there are operations so mechanical as 
to call for no intellectual effort and only a slight and uniform 
physical effort. An ideal social system would give to every 
one a share of both kinds of work. Man is not a machine, 
and to treat him as one is to make him something less than a 
man. If the process of work is to contribute to welfare, it 
must have variety. Variety is needed to give scope for initia- 
tive and choice ; work without variety exercises only a part 
of the man, and the faculties which are not exercised tend 
to atrophy. Art is good work, because it has an infinite 
variety ; it is an unending exploration ; once the artist be- 
gins to repeat himself, to do the same kind of thing in the 
same way over and over again, his work becomes conventional 
and loses its quality. Bad work is exempHfied by the tending 
of some automatic machines ; the worker is part of the ma- 
chine ; there is no room for the exercise of choice, no scope for 
originality ; what he shall do and how he shall do it is deter- 



4IO Economics for the General Reader 

mined for him, and it is his business to fit himself to the 
routine of the machine ; once the routine is learned no further 
call is made on his intellectual faculties, and the range of 
movements may be so narrow that only a small part of his 
physical powers are exercised. The effect on such a worker 
of the mechanical monotony of his work may be counter- 
acted by influences outside his work, but his work is such 
that it contributes nothing to the development of his faculties ; 
his work is so much time taken out of his life, so much vital 
energy turned to waste, so far as the development of himself 
is affected. The creative worker by contrast is most alive 
when at work, and receives a full reward for his work in the 
pleasure of it and the addition it makes to his personality 
whether he ,be paid for the product or not. 

Control, — With the process of production the control of 
production is closely connected. Where the process of pro- 
duction is subdivided and subdivided, and the human element 
linked up with power machinery, the individual worker will 
have little control over his life at work, he will have little 
freedom in the sense of self-direction, little independence. 
The speed, order, and conditions of work will all be set for 
him ; initiative, responsibility, direction will be concentrated 
on the few and taken out of the work of the many. Special- 
ization involves the subordination of the detail-workers to 
the organizers of industry, and such subordination gives 
an opening for tyranny; the modern worker has enlisted 
in an army in which discipline, the subordination of the mass 
of individuals to authority, is just as necessary to the system 
as it is in any military force. When capitalism — the private 
ownership and control of the nonhuman element in pro- 
duction — is added to specialization, the individual worker's 
freedom is limited still further ; but even with public owner- 
ship of capital, the system involves the subordination of the 
many to the few, it affords openings for speeding up, bullying, 
victimization ; public employees are not the most contented 



Wealth and Welfare — Economic Influences on Welfare 411 

class of the community. Where on the other hand the process 
of production is not subdivided, so that work retains its 
variety, there the independence and self -direction of the worker 
survive ; the same person has to decide what to do, how to do 
it, at what rate to work, and how cooperation with other 
workers shall be organized. 

According to most views of welfare, it is better for people 
to control their own actions than to have all their actions 
dictated to them ; initiative is better than blind acquiescence 
in the initiative of others. This belief is the basis of poHtical 
liberty or self-government ; the right of every one to a share 
in the government of the country is regarded by the democrat 
not only as a means of securing a just and efficient govern- 
ment, but as a fundamental attribute of citizenship ; democ- 
racy or political Uberty includes the right to misgovern oneself. 
Slavery is regarded as an evil and forbidden on similar grounds ; 
the slave has no legal control over his own activities. If work 
then is to contribute to welfare directly, and not only in- 
directly through its product, the control of work must be 
diffused as widely as possible, the work of " management " 
must be distributed, methods of voluntary cooperation de- 
vised to take the place of the direct imperative of the captains 
(and the other officers) of industry. It should be an aim of 
economic organization to reserve to the individuals in it as 
ample a control over their own activities during work as is 
consistent with the end of work being achieved and wealth 
produced ; the two aims must be balanced against each other, 
and neither be sacrificed to the other. 

IV 

The Sacrifice of Producer to Product 

The Survival of "Little Masters." — In the light of this 
double end of the economic organization, certain forms of 



412 Economics for the General Reader 

organization, which are condemned v/hen judged merely by 
their productivity, acquire a new interest, since they may con- 
tribute to welfare directly, out of all proportion to their pro- 
ductivity. Small firms multiply in industries in which all the 
economic advantages seem to lie with large firms, because 
enterprising men prefer to be their own masters. The " little 
master " system of manufacture, when the little master is 
really his own master and not the slave of the middleman, 
draws strength to survive from the same motive. The hand- 
loom weavers of the early nineteenth century, even under the 
pressure of extreme poverty, refused to enter the factories 
where their lives would be ordered by the factory bell ; and 
the peasants of the same generation, who lost the status of 
independent farmers through inclosures, felt themselves 
wronged in spite of the experts, and transmitted the feeling 
to their descendants. 

The Coddling of Agriculture. — An importance is some- 
times attached by statesmen to agriculture, and especially 
to small holdings, which is not justified by the ordinary view 
of production. If the products of an industry can be obtained 
from abroad more cheaply than they can at home, it is con- 
sidered good policy to import them, and to develop for export 
some industry for which the country has greater advantages ; 
in the case of agriculture alone, Free Trade politicians are not 
content with this policy, and propose all sorts of subsidies, 
such as loans and railways below cost price, and interferences 
with the normal course of economic arrangements, such as 
State-fixing of rent and wages. In the case of other forms 
of wealth the owner is allowed to use it as he will, not so in 
the case of land ; it is not wrong to keep for one's pleasure 
a twenty-roomed house in an overcrowded city, but ap- 
parently it is wrong to keep for one's pleasure land that could 
be used for small holdings. The exceptional position among 
occupations thus attributed to small agriculture is often a 
mere piece of sentimentalism ; but it has sound justification. 



Wealth and Welfare — Economic Influences on Welfare 413 

The work of a farmer has more variety, more room for initia- 
tive and self-direction than the work of the ordinary artisan 
or foreman ; and agriculture is the chief branch of production 
in which economic advantages are not on the side of large-scale 
production. The German statesmen of the early nineteenth 
century who preserved their small farmer class had a wider 
conception of welfare than the English statesmen who sac- 
rificed their peasant class to increase the productivity of 
land. 

Cooperation. — From this point of view again the coopera- 
tive movement in industrial organization acquires an en- 
hanced importance. Cooperative stores to a slight extent 
and cooperative associations of producers to a very great 
extent distribute the work of industrial management; they 
avoid that subordination of companies and regiments of 
workers to the will of a single " captain " of industry, which 
is the mark of private employment. The very difl&culty of 
organizing them is an additional reason for persisting in the 
attempt to organize them, since the difficulty consists in in- 
ducing people to work together without compulsion, and 
nothing develops the pleasanter sides of human nature more 
effectively than the practice of such voluntary cooperation. 
The moral effects of the system are a more important part 
of its claim than its economic results. 

Work and Personality. — Work, then, if it is to contribute 
to welfare directly, should be such as to develop the worker's 
personality. For this it must have variety, it must be re- 
sponsible, it must afford him scope for initiative and self- 
direction; there must be individuality in the object, the 
process, and the control of work. If all work were of this 
nature, the curse of Adam would be overcome. It is im- 
possible that all work should be of this nature ; but much 
more attention might be paid to this influence on welfare 
in schemes of social reconstruction. The principle lacks 
recognition that workers are entitled to be treated as persons, 



414 Economics for the General Reader 

not merely as " hands " ; William Morris met with little 
response when he preached the gospel of work as a way of life 
as well as a means of liveUhood, a gospel he could preach be- 
cause he practiced it. The chief tendencies of modern in- 
dustry are against the recognition of this principle, because 
the underlying principle of them is specialization. Special- 
ization is enormously productive ; product is obvious and can 
be measured, while the other influences of the economic or- 
ganization on welfare cannot be measured and are easily over- 
looked. Requiring a large and uniform output, speciaHza- 
tion destroys individuality in the object of work ; by subdivid- 
ing the process of manufacture, it prevents the workman 
from having an interest in the manufacture as a whole ; by 
simplifying processes it makes them mechanical, and there- 
fore fit work for machines, not for men ; and instead of diffus- 
ing control and responsibility it concentrates them on a few 
" captains of industry " on the specious ground of efficiency 
— efficiency meaning, in nearly every case, the sacrifice of 
the worker's humanity to the needs of material production. 
In pursuit of the economies of specialization individuals have, 
by private contracts, created an economic system which no 
individual can control, and which controls every individual. 

Importance of Nature and Conditions of Work. — There are 
two reasons especially why the influence which the nature 
and conditions of work exert upon welfare needs attention. 
The first is that the product, to which specialization tends to 
sacrifice the producer, is in so many cases worthless measured 
by any but commercial standards ; as we have seen, many of 
the goods and services that constitute modern wealth con- 
tribute nothing to welfare, and may even by destroying the 
taste for better things detract from welfare. The other is 
that work is an influence that none of the masses escape. Ex- 
cept the home, it is the most important social influence we 
have to reckon with in the formation of character. The ele- 
mentary school reaches all, but only up to the end of child- 



Wealth and Welfare — Economic Influences on Welfare 415 

hood ; other forms of education touch only a fraction. Or- 
ganized religion touches an even smaller fraction than the 
continuation school. Conscription down to the Great War 
was the exception in English-speaking countries. Even the 
home, under the pressure of the economic system, which treats 
the individual, not the family, as the unit of society, is losing 
the influence it possessed. On the other hand, work must 
always have the first claim on a man's energy, time, and 
abihty. Leisure and all its possibilities may be, and in 
many cases will be, abused ; work is conditioned by forces 
which the individual does not control. If, therefore, society 
organizes industry so as to make work mechanical, the people 
will be mechanical ; if it allows no scope for the exercise of 
the aesthetic faculties, these faculties will tend to atrophy; 
if initiative and responsibiHty are taken out of the work of the 
ordinary man and concentrated on " captains of industry," 
the ordinary man will become a creature of routine, incapable 
of responsibility ; and society will not be sure even of a con- 
tinued supply of " captains." The wise use of leisure may 
counteract these tendencies ; but there is no certainty that 
leisure will be used wisely, while the influence of work is 
certain. 

Recognition of Relation between Work and Welfare. — 
The influence of work on welfare is not without recognition, 
William James described the introduction of manual training as 
the most colossal improvement which recent years have seen in 
secondary education. The separation of physical and mental 
labor which modern industry favors is seen to be bad for 
both manual worker and brain worker. Educationalists are 
beginning painfully to reproduce in the schools the kind of 
training that handicraft used to give at work; an educa- 
tional system is a necessity only under a system of unedu- 
cative work. Before the rise of modern industry, much more 
importance was attached to the point of view of the producer. 
Industry was regulated by associations of producers, gilds, and 



4i6 Economics for the General Reader 

companies, to whom was left the regulation of conditions and 
quality. The manual worker has always refused to adopt 
the economist's way of looking at industry solely from the 
point of view of the consumer ; for him conditions are as im- 
portant as wages; speeding up, overtime, petty tyranny, 
and victimization are evils as great as low wages ; the trade 
union is for him the fundamental social organization, because 
it is elastic in its objects and can be directed against any of 
these evils. Hence the significance of the latest manifesta- 
tion of the democratic spirit, Syndicalism, the claim that the 
workers shall control the conditions of work. 

To criticize Syndicahsm on the ground that the adopting 
of its proposals would decrease the product of industry is 
beside the point ; its criticism of society is based on the view 
that conditions are as important as product. To object 
that its practical proposals are visionary and unpractical, 
even if true, does not affect the force of its criticisms ; the 
proposals of Owen and the Utopian socialists were unpractical, 
but their criticism of anarchic individualism in industry was 
sound, and their assertion of the need of social control of 
industry has received the sanction of subsequent legislation. 
The attitude to reform against which Syndicalism is a protest 
accepts the materialist assumption of the present economic 
system, that economic welfare depends on the amount of 
product; it is illustrated by the remark sometimes made 
that the Industrial Revolution solved the problem of pro- 
duction, while the task of this age is to solve the problem of 
distribution. So far from the Industrial Revolution solving 
the problem of production, it would be truer to say that it 
created it. The whole-hearted acceptance of the principle 
of specialization, which was the essence of the Industrial 
Revolution^, leads inevitably to the sacrifice of the producer 
to the product; a reformed distribution, desirable in itself, 
would merely compensate him by giving him a larger share 
of the product — in much the same way as a Railway Company 



Wealth and Welfare — Economic Influences on Welfare 417 

cripples an employee for life, and " compensates " him with 
a payment of a couple of thousands of dollars. The Industrial 
Revolution has left the whole Western world with the liability 
on its hands of a population many times as great as it was 
before — a population so dense that society cannot dispense 
with specialization, in spite of its evils. From the point 
of view of those evils, however, socialism is a mere palliative ; 
indeed the State, when it takes over any service, exaggerates 
them, carrying specialization to hitherto unknown lengths 
by the creation of " experts," and by centralizing responsi- 
bility and initiative to a degree unknown in private industry. 
Aristotle defined a slave as a " living tool," and the phrase 
describes precisely the wage-earners in industries that have 
passed through the Industrial Revolution; the majority of 
Government employees are in the same category. 



ai 



CHAPTER XXV 
WEALTH AND WELFARE — BUSINESS AND MORALITY 



Welfare Regarded as Independent of Wealth in Some Systems 

of Morality 

We have seen that money, the measure of wealth, is a very 
inadequate measure of the welfare afforded by the economic 
organization ; the product of that organization is only one 
channel through which it influences welfare. How little this 
measure may tell us about welfare, however, we can realize 
only when we remember that in some important ethical 
systems wealth is treated as a very subordinate influence 
on welfare, welfare being attainable only by subordinating 
wealth to other influences on welfare. It falls outside the 
scope of economics to define welfare, but it is necessary 
to an understanding of the limits of economics to point 
out that such views of welfare and wealth are held. The 
sources of human satisfactions or welfare may be divided 
roughly into two classes, internal and external sources; 
wealth is one of the external sources. Materialism is the 
subordination of the internal sources of satisfaction to the 
external ; most reHgions exalt the internal over the external, 
and teach that welfare lies in the former, to which the latter 
must be sacrificed : " The Kingdom of Heaven is within 
you." 

Different Attitudes Toward Wealth. — The religious view 
of wealth is not so inconsistent with common practice as at 

418 



Wealth and Welfare — Business and Morality 419 

first sight appears. Wealth seems to be an aim of every one 
and the aim of many. Many, however, who seek it seek it 
merely as a means to other things. A Cecil Rhodes will seek 
it as the means of realizing his political ideals ; and others, 
without his ideaHsm, will seek it as the index of social success. 
Under the system of free enterprise, wealth is the chief means 
of power and influence over others ; if other means were 
devised, they would be sought by the people with ideals to 
realize, and the people with no clear ideal, but only personal 
ambition to satisfy, would follow suit. In England an ambi- 
tious man gives up accumulating wealth after a time, and 
goes into politics or buys a title ; in America, where there are 
no titles, and politics are often subordinate to finance, he 
goes on accumulating wealth indefinitely, not for its own 
sake, but as the only source of influence and the only index 
of success. The Christian view of wealth would seem to be 
that wealth is less important for welfare than the internal 
sources of satisfaction ; an increase of wealth is not necessarily 
an increase of welfare, and wealth should not be allowed to 
stand in the way of other kinds of welfare ; it is not impossible 
for a rich man to enter the Kingdom of Heaven, but his riches 
are as great an obstacle to entering the Kingdom as a camel's 
load is to passing through a postern gate. It is not of course 
contended that an increase of wealth brings no satisfaction 
and adds nothing to welfare, but only that satisfactions 
derived from external sources are the more transient, and to 
build one's welfare on the possession of wealth is to hold it 
by a precarious tenure. And this view of wealth is supported 
by the practice of the great mass of mankind. Even in the 
countries that have passed through the Industrial Revolution, 
the working classes and the professional class seek a secure 
sufficiency rather than a constant increase of wealth ; their 
chief interests lie in other directions. The rich use their riches 
to deprive themselves of the comforts of civilization and to 
gain opportunities of experiencing the hardships and excite- 



420 Economics for the General Reader 

ment of primitive life, hunting big game or climbing moun- 
tains; the schools of the rich, especially in a country like 
England, teach hardship rather than comfort. The rich 
as a class are no happier and no better than the poor as a class. 
If we compare different ages and countries, we are struck 
by the apparent unimportance of wealth. The materialist 
regards the vulgar plenty of the twentieth century as great- 
ness ; others will regard its art as a better index of an age or a 
country's temper. Whichever is right, the two great ages of 
art, the two periods when craftsmen were artists and the 
appreciation of art was general, were ages of extreme material 
poverty ; and few will assert that the age of Arkwright was 
greater than the age of Pheidias, the civilization of Chicago 
than the civilization of Athens ; few, who have studied both 
and compare achievement with opportunity, will place the 
art of the thirteenth century below the art of the Victorian 
age, the age that built the cathedrals below the age that 
restored them. As society has grown richer, art has become 
more and more the concern of little cliques and coteries, less 
and less a part of the everyday life of ordinary people, until 
to-day we have countries like the United States, so rich that its 
Whistlers and Sargents fly to the poorer countries of Europe. 
If religion rather than art be taken as index of the age or 
country's temper, the comparison will be even less flattering 
to the richer modern countries. 

II 

The Economic Organization not Necessarily a Reflection of 
Current Moral Standards 

Is Welfare an Economic Question? — It is sometimes 
maintained that the considerations which have occupied us 
in the last few pages are both irrelevant and unnecessary. 
They are irrelevant, it is maintained, because they are ethical, 



Wealth and Welfare — Business and Morality 421 

not economic, considerations. Economics is the study of the 
social organization for satisfying wants, the means of satisfy- 
ing which are limited in quantity ; the organization can be 
studied, and its efficiency judged without going into the 
question of the kind of wants society seeks to satisfy. They 
are urmecessary, because the system of free enterprise insures 
automatically that the economic organization and its products 
will conform to the standards of taste and conduct of the time. 
Those things are made which are wanted, since there is 
freedom to make anything; those methods of production 
are adopted which society thinks best, since the State pre- 
scribes no set form of organization ; those economic relations 
are established that give a maximum of convenience, since the 
individuals in society are left free to establish what relations 
they think best. The economic organization is responsive 
to every change in the direction of people's wants and ideals, 
and is therefore the necessary outcome and reflection of 
current views of welfare. Business is neither moral nor 
immoral ; it is neutral, directing itself to meeting whatever 
wants are expressed. If the results of the economic system 
are repugnant to our moral sense, we must take steps to 
change the moral ideas of the people whom the economic 
system serves ; the economic system being merely responsive 
to demand, we must change the nature of demand. Reform 
must come by changing the public's standards of satisfaction ; 
to attack the organization for satisfying wants is to tinker 
with symptoms and to neglect the cause of the evil. 

Economic Evils as Symptoms. — This objection to our 
argument contains an important half truth. Undoubtedly to 
a certain extent the economic organization is responsive to 
changes of taste and conduct, and its works are a reflection of 
them. If people are bad, under any system the products of 
industry will be bad ; if they are careless of beauty, the prod- 
ucts will be ugly ; if they are careless of one another's rights, 
there will be oppression and injustice ; if they are selfish, 



422 Economics for the General Reader 

there will be an unequal distribution of the benefits of the 
organization. Conversely, any improvement in morals will 
affect the economic organization. The greatest social evil of 
the day is not the inequality of wealth, but the selfishness and 
insensibility to the sufferings of others that makes all attempt 
to secure greater equality so difficult. If the Christian 
Churches' preaching of the unimportance of wealth and the 
duty of unselfishness were effective, the path of reform would 
be smoothed. The objection is important, too, because it 
underlies much of the opposition to all attempts to moralize 
the economic system by State action. The system, it is 
thought, is an automatic system ; free enterprise insures that 
it will reflect current morality, and it can be improved only 
by raising the level of current morality. 

Fundamental Character of Economic Evils. — In spite, 
however, of the half truth it contains, the objection is unsound. 
It exaggerates the responsiveness of the economic organization 
to changes in standards — we are bound to examine how far 
it is responsive ; it is quite without justification in assuming 
that private arrangements between individuals are either the 
only or an adequate way of moralizing the economic organi- 
zation; and it ignores the reaction of the economic 
organization on standards of taste and conduct. The 
economic organization is responsive to demand, but demand 
is not the same thing as want or need ; demand is no guarantee 
of desirability by any standard other than those of the 
market. Not need but purchasing power gives the direction 
which production shall take. The economic system is respon- 
sive to people's views only in so far as they can exercise 
purchasing power. Those who devote themselves to altruistic 
objects and neglect the pursuit to private wealth will exercise 
little influence on the system through the ordinary channels on 
which the policy of free enterprise relies; a St. Francis, 
vowed to poverty, would have no influence through those 
channels at all. Those, on the other hand, who subordinate 



Wealth and Welfare — Bminess and Morality 423 

everything else to money-getting will exercise the greatest 
influence. The organization would be responsive to need, it 
would reflect the moral and aesthetic standards of the age, 
only if wealth were equally distributed. 

Difificulty of Determining Welfare. — Even if the condition 
that purchasing power must be fairly evenly divided were 
satisfied, the system of free enterprise would not insure 
conformity of the economic organization to the moral stand- 
ards of society. Only if people, when they made their pur- 
chases or entered into other economic relations, did exactly 
what they knew or thought to be their highest interest would 
such conformity arise from freedom of enterprise. The 
argument that free enterprise is all that is needed to insure 
conformity of the economic organization to current standards 
ignores the unfortunate tendency in human beings to do 
what they know to be bad for them and to leave undone what 
they know to be good for them — the tendency that theolo- 
gians call " original sin." The argument is the argument of 
anarchy ; it goes further than the advocates of free enterprise 
recognize, and would leave no room for the State at all. If 
economic relations and activities can be left to the " free 
enterprise " of individuals, and the State be confined to 
enforcing their private contracts, so may other relations 
and activities. If " free enterprise " or laissezfaire will secure 
the conformity of industry to moral standards, why not of 
everything else ? Why not leave the relations of the sexes to 
unrestricted freedom of enterprise? 

Broader Implications of Laissez Faire. — Indeed, the policy 
of free enterprise or laissez faire is an expression of the same 
social philosophy, and based on the same conception of human 
nature, as the policy of " free love." That conception is the 
rationalist conception, on which utilitarian individualism was 
based — the conception that people will do what is reasonable 
without assistance, so that all that is needed is to set them 
free to pursue their enlightened self-interest. On tliis con- 



424 Economics for the General Reader 

ception of human nature all laws are unnecessary. Laws, 
so far as they are good laws, require people to do only what is 
reasonable and in the best interests of the community : if 
people can be relied on to do what is reasonable and in their 
best interests, just because it is reasonable and in their best 
interests, laws which force them to do so are obviously not 
needed. In practice the fact that a thing is reasonable and 
to their interest is not sufficient to insure that people will do 
it: most people, if they are candid, will sometimes confess 
with St. Paul : " That which I do, I allow not : for what I 
would, that do I not : but what I hate, that do I." In minor 
matters as well as in major — they take more drink than is 
good for them, food which they know will disagree with them, 
buy clothes they cannot really afford, idle when they know 
they ought to be working, sit up when they know they ought 
to be in bed, lie in bed when they know they ought to get up, 
and hurry into their clothes when they know a cold bath would 
be good for them : and in their economic relations they dis- 
play the same human, if irrational, weakness. To overcome 
this tendency they need all the supports they can devise, and 
the State is one of the strongest supports they have devised. 
Everybody knows that it is bad to steal, to kill, to commit 
bigamy, to exceed the speed limit ; but we do not rely on that 
knowledge to prevent these crimes, and we have therefore 
made arrangements through the State to prevent them. We 
are constantly passing laws to register a rise in the level of our 
morality and prevent any lapse below it in the future. Not 
only do we make secure in this way advances we have made, 
but we habitually use legislation to screw up the level of 
morality a little higher than it is. No department of human 
activity that has a social aspect can be exempt from this 
action of the State, and industry to-day is of all activities the 
most social. If all men were Christians, economic relations 
might perhaps be left to the unregulated enterprise of private 
contract, because all men would have been cured of original 



Wealth and Welfare — Business and Morality 425 

sin, this tendency to sacrifice their higher interests to imme- 
diate gratification or sheer inertia ; as they are, however, men 
cannot dispense with the checks they impose on their impulsive- 
ness and selfishness through the machinery of the State. The 
moral standards of society embody the average conception 
of our highest interests : they wiU not for that reason by itself 
have an effective authority over the individual, but require all 
the buttressing that the State, law, rehgion, and education 
can do to uphold them. 

We cannot therefore ignore the bearing on wealth of 
different conceptions of welfare, on the ground that under 
a system of free enterprise the economic organization and 
its products will automatically conform to the current 
conception of welfare and reflect every change in it. To 
the extent to which enterprise is free, we shall expect the 
morality of business to fall below the moral standards of the 
time, and we shall not be surprised to find that the economic 
organization in the past has been morab'zed by the direct 
action of the State quite as much as through the economic 
actions of individuals : the abolition of slavery, the reform of 
the early factories, the abolition of infant labor in mines, the 
regulation of dangerous trades, the prevention of deleterious 
adulteration, the prevention of excessive drinking, to take 
only a few instances, have all needed the intervention of the 
State. 

Ill 

Reaction of the Economic Organization on Moral Standards 

Materialistic Reaction. — Nor can we exclude all considera- 
tion of different views of welfare on the ground that wealth 
and welfare are distinct and can be studied each in abstraction 
from the other. The two things can, of course, be separated 
for purposes of study, but not permanently, because they are 
not distinct : the economic organization is not the mere 



426 Economics for the General Reader 

outcome of our conception of welfare, it reacts upon it. 
Different systems of morality produce different types of 
economic organization, but, just as truly, different economic 
systems produce different tj^es of morality; the economic 
organization is not like a motor that will take us anywhere, 
it will take us only in certain directions, and may even run 
away with us. The reaction of the economic organization 
on social standards of conduct is similar to the more obvious 
reaction on standards of taste. It is easily seen that it is 
only nominally responsive to aesthetic demands ; it is adapted 
to producing quantity so much more than quality, " standard " 
mechanical articles so much more than individual and char- 
acteristic articles, that society is forced in practice to take the 
former instead of the latter ; taste is formed on the objects it 
contemplates, and smooth finish comes to be preferred to 
vigor of design, the novelty of transient fashion to true 
originality based on tradition. In the same way the economic 
organization facilitates certain kinds of conduct and favors 
the development of certain types of character, and handicaps 
other types of character. The direction which its influence 
takes is due to the identification of wealth with product. 
We have seen that it makes increase of product the sole 
end of its organization; the principle on which it bases 
distribution is productivity or contribution to product; it 
estimates the increase of wealth solely by measuring product — 
so far as it can be measured. Now if we treat product alone 
as wealth, and arrogate the term wealth, which in a broad 
sense means anything that satisfies a want, to product, which 
covers only external sources of satisfaction, inevitably we 
suggest that the internal sources of satisfaction are not wealth, 
we give a materialistic tendency to our aims and values. This 
the present economic system does, because it is based on this 
narrow conception of wealth. 

Influence of Definiteness of Economic Values. — Certain 
incidents of the system accentuate the tendency to materialism. 



Wealth and Welfare — Business and Morality 427 

The first is that wealth in this narrow sense is definite and 
measurable. There are other scales of value — moral, 
aesthetic, political — in which actions and qualities which 
have a low economic value — self-sacrifice, heroism, beauty, 
" the pure, gemlike flame of devotion to art," for example — 
have a high place ; but economic values are the only values 
definitely measured. The measure means little, the definite- 
ness disappears when we look beneath the surface and find that 
economic values change with every change in the distribution 
of wealth; but wealth retains this advantage over internal 
sources of satisfaction, that it is subjected to a quantitive 
measure and stated in terms of a unit. This superficial 
definiteness gives economic valuations an advantage when 
they come into conflict with other valuations, because the 
influence of an idea on conduct depends very largely on its 
sharpness of outline ; definiteness commands assent, while 
vagueness invites questioning. When, therefore, a community 
or an individual has to choose between a course of action which 
will add to wealth and a course of action required by a vague 
but just sense of honor or duty, the fact that the advantage 
of the former can be stated in terms of dollars and cents 
gives it an influence it would not otherwise exert. The in- 
fluence is exerted most frequently, however, when different 
conceptions of advantage are competing and there is no 
obvious conflict between advantage and duty ; in expenditure 
on education, for example, the appeal of technical education is 
nearly always more forcible than the appeal of liberal educa- 
tion, because the results of the former can be stated in the 
addition of so many dollars a year to the earning capacity of 
the student, or the addition of so many dollars' value to the 
trade of the town, while the latter merely makes better men 
and women. Additions to wealth, being measurable, are 
spoken of as " solid," " material," or " practical " advan- 
tages ; all other additions to welfare are lumped together as 
" matters of sentiment," by implication unreal, unpractical, 



428 Economics for the General Reader 

and immaterial. The economic measure is a useful aid to the 
study of wealth, it becomes a danger when its limitations are 
ignored ; if science is measurement, wisdom is the appreciation 
of that which cannot be measured. 

Influence of Individual Insecurity. — A second incident of 
the present economic system which accentuates its materialistic 
tendency is the insecurity of the individual's economic position 
under it. This insecurity is claimed as an advantage, since 
it exerts a constant pressure on the individual to work, and 
so insures the maintenance and increase of the flow of wealth. 
The organizers of production have to " get on or get out," the 
lazy among the working class are kept to their work by the 
fear of unemployment, the investing class are compelled 
to watch their investments, and therefore to apply their 
capital to the most productive uses, by the losses that quickly 
attend bad management of a company. No one is guaranteed 
his position, his income, his work, or his trade connection; 
each is left to get out of the economic organization only what 
the competition of others will allow him to get. Two results 
follow : first, the minimum of wealth, which is necessary to a 
reasonable life and with which idealists of all sorts would be 
content, can be secured only by a constant struggle to get 
more than the minimum. A man may be genuinely anxious 
to take no thought for the morrow ; but he has his living to 
think about, and a living can only be secured by constant 
taking of thought for the morrow. However little a man cares 
about wealth he is forced to be constantly thinking about it ; 
hence wealth and wealth-getting activities have an importance 
in modern life that bears no necessary relation to their con- 
tribution to welfare. Secondly, the increase of wealth which 
the system induces is unevenly distributed; if the poor do 
not get poorer, the rich get richer. Hence social standards of 
expenditure are constantly upset; the pace is made by the 
energetic and acquisitive, and the great mass of ordinary 
people, who would be content with what they have if only 



Wealth and Welfare — Business and Morality 429 

these others would be content also, are made to feel poor 
by comparison. A system based on contract rather than 
status may make for the increase of wealth ; but happiness 
depends more on security of status than on increase of wealth. 

Influence of Method of Distribution. — A third incident 
of the system, strengthening its materialistic tendency, is its 
method of distribution. The essence of morality, on any 
except a crude materialist view of morality, lies in distinguish- 
ing between kinds of satisfaction ; the essence of the present 
economic system is that it makes no distmction at all between 
kinds of satisfaction in distributing rewards. The principle 
on which the distribution of income is based, so far as it is 
based on any principle, is that of productivity ; the aim of the 
system may be said to be to secure for each a share of the 
product proportionate to the contribution to production 
made by his labor or his property ; and anything that 
satisfies a want, without distinction of kind of satisfaction, 
ranks as product. We pay a publican more for making a man 
drunk than for keeping him sober. In taking this attitude 
the economic system may merely reflect current morality and 
taste. We have seen reason for thinking that it does not, 
since it responds to casual impulse rather than to deliberate 
choice ; but whether it reflects current morahty or not, it 
does ignore distinctions in kind of satisfaction, and by so doing 
inevitably suggests that distinctions in kind of satisfaction are 
negligible. We need not believe that the hope of material 
reward is the only motive of action in order to recognize that 
the distribution of material rewards influences action ; if, 
therefore, in the distribution of the material rewards at the 
disposal of industry the distinction between permanent 
services and transient satisfactions is ignored, the distinction 
between them will be weakened in the public mind. 

Further, while the principle of the present system of dis- 
tribution is contribution to product, there are many ex- 
ceptions to the principle. A considerable number of incomes, 



430 Economics for the General Reader 

we have seen, consist of payments received for no service, but 
the reverse of service ; monopoly profits secured by restrict- 
ing supply, speculative profits made by producing artificial 
price-fluctuations, the unearned increment of land withheld 
from the market during the growth of a town, make in- 
dividuals rich at the expense of the community. Riches 
so obtained, however, have the same purchasing power as 
riches obtained by serving the community; they give their 
owner the same influence over the lives of other members 
of the community. Hence the distinction between social 
and antisocial effort tends to be obliterated; wealth is 
respectable, however won, and great wealth is honored, 
because it is powerful, whatever its source. The extreme 
complication of the modern economic system helps this 
confusion. It is often difficult to ascertain how wealth is 
acquired, diflScult to follow out all the effects of a certain 
way of acquiring wealth; it is easier and much simpler to 
give up the attempt to discriminate, to lump together all 
methods of making wealth, and to concentrate one's en- 
deavors on securing a good use of wealth. It is increasingly 
difficult for the investor and consumer to make sure that he 
is not profiting by native slavery, sweating, or some other 
way of exploiting the weak. Because industry is social 
the individual seems helpless in the face of its evils, and the 
feeling arises that morality and business are something apart, 
that business is something outside the scope of the ordinary 
canons of morality. 

IV 

Materialistic Tendency of Economic Influences To-day 

In considering the action and reaction on each other of 
the economic organization and morality, it is difficult to 
disentangle cause and effect; so much, however, is clear, 
that the economic organization, by lending itself so readily 



Wealth and Welfare — Business and Morality 431 

to the materialistic tendencies of society, strengthens them 
at the expense of the idealist tendencies. A saloon at every 
street corner may not cause drunkenness, it does very seriously 
increase the difficulties of the drunkard who is trying to 
reform himself ; in the same way an economic organization 
which serves all kinds of wants indifferently and rewards all 
kinds of satisfactions indifferently may not cause materialism, 
but it certainly strengthens any tendency to materialism 
there may be in society. Materialism may of course be 
right, pleasure may be the true end of life ; here we are only 
concerned to point out the tendencies of the present economic 
organization, and these are to support materialism. 

Habitual Pursuit of Wealth. — The extent to which the 
economic system influences the conception of welfare may be 
overlooked, because it seems absurd on reflection to identify 
wealth, the means of welfare, with welfare itself; any one 
who asks himself the question what wealth is for, must per- 
ceive that it is only a means to something else. So few people, 
however, do ask themselves the question; the identification 
of wealth and welfare is unconscious ; the belief is not avowed. 
The existence of the belief, however, is to be traced in its 
effects. The pursuit of wealth, by the individual or the 
conmiunity, becomes habitual ; and the question how far the 
satisfaction given by any increase of wealth is worth the 
trouble of obtaining it, is seldom raised. Progress is con- 
ceived as the mere multiplication of material things ; and 
countries which have thought more of the use of wealth than 
its increase, and work to live instead of living to work, are 
stigmatized as " unprogressive." Every social reform has 
been opposed on the ground that it might " dry up the 
springs of wealth," and the advocates of the reforms have 
usually taken the same ground as the opponents and argued 
that the reform would bring no decrease in wealth. The system 
of free enterprise, in which no one's status is secure and peace 
is not a harmony, but merely an equilibrium of hostile forces, 



432 Economics for the General Reader 

is defended (and often criticized) solely from this point of view. 
Statesmen advocate the feeding and medical treatment of 
school children, not on the ground that the children suffer, but 
on the ground that the expenditure will be an " investment," 
and will increase wealth in the future ; their true motive may 
be sympathy for the children, but they dare not avow it and 
must plead material expediency. Continuation schools are 
usually treated as an aid to industry, and their work made 
narrowly technical. Frequent complaints are made that 
elementary education is not equally "practical" or "useful," 
w:liich means equally adapted to subserve the needs of in- 
dustrialism. Attempts are even made to capture the univer- 
sities for the same mean ideal, that man exists for production 
and the aim of education must be to make ever more efficient 
producers ; an eminent educationalist has defined universities 
as " the technical schools of the brain-working classes " ! 
It is impossible to make some people see that as great an 
addition to welfare is made by teaching a boy to enjoy a 
book as by teaching him to print or bind it, by giving him 
a love of some art as by instructing him in some technical 
craft, and that education should be treated not as an aid but 
as a palliative of industrialism; the end is forgotten in the 
means : 

their visidh is 
Machines for making more machines. 

The treatment of the rich illustrates the same tendency. 
An artist may have to wait till he is dead for the fame which 
pompensates him for poverty; a prophet is not so much 
without honor as ignored or treated as a joke. The million- 
aire, on the other hand, whether his wealth be the reward of 
real services to the community or the profits of a successful 
corner in wheat or due to the accident of birth, has every- 
thing that society can give lavished upon him. Churches 
give him the first place in their councils, and universities 



Wealth and Welfare — Business and Morality 433 

confer degrees upon him. His most casual utterances on 
subjects he does not understand are treasured as the words 
of wisdom ; and the more democratic his country is, the 
easier it is for him to attain to political power. 

Dependence upon Wealth Standards. — How profound, 
however, is the influence of the economic organization on moral 
standards is shown perhaps best by the usage of ordinary 
speech. Political idealists speak of the flag, the symbol of 
nationhood, as " the greatest asset " of the nation. Political 
corrtiption is denounced on the ground that it is " bad busi- 
ness." War is deprecated because it no longer " pays." 
Honesty is commended because it is " the best policy." 
We say, in what Gissing called " the vulgarest saw that ever 
disgraced a nation," that " time is money " ; we measure a 
man's worth by his wealth, and say he is " worth a million " ; 
we frankly identify wealth and welfare by describing a man as 
" well off " or " badly off " according to his income. Dis- 
honesty, when successful, is admired rather than the reverse, 
as " smartness " ; and the characteristics that business 
develops — self-assertion, keenness, and an insensibility to fine 
scruples and feelings — are the very reverse of the humility, 
content, and self-sacrifice inculcated by the professed religion. 
It was this materialism, or " utihtarianism " as Morris called 
it, " which, being interpreted, means the reckless waste of life 
in the pursuit of the means of life," that the ideahsts of the 
nineteenth century, Carlyle, Ruskin, and Morris, attacked ; 
all attributed it to the same cause, the influence of the economic 
system established by the Industrial Revolution ; and all 
extended their attacks to the economists who explained the 
system, for ignoring the effects of the system on standards of 
taste and conduct. 



at 



434 Economics for the General Reader 



How Wealth Contributes to Welfare 

We may now summarize our discussion of wealth and 
welfare, and state such conclusions as can be drawn from it. 
The word " wealth " is used in two senses : in the sense of 
product, the ordinary sense, and that in which it is used in 
Economics ; and as meaning welfare, the sense in which Ruskin 
used it. We decided to keep the word " wealth " for product 
and use the word " welfare " for the second sense ; the object 
of our inquiry was to discover the relation of wealth to wel- 
fare. Wealth, we found, could be measured, and the best 
method of procedure seemed to be to inquire how far the 
measure of wealth indicated welfare. 

In the first place, we found the measure of wealth defective, 
since it takes account of some kinds of property that are 
not wealth and leaves out of account some forms of wealth 
that do not come into the circle of exchange. Secondly, we 
found the measure of wealth misleading, because the value of 
a thing does not indicate the absolute amount of satisfaction 
the thing gives, depending as value does on the distribution 
of purchasing-power. Thirdly, we found that the measure of 
wealth, strictly in accordance with the usage of ordinary 
speech, takes account only of amount of product ; the satis- 
faction or welfare derived from wealth, on the other hand, 
depends largely on the use of wealth by society and the in- 
dividual, i.e. on distribution and consumption. In the fourth 
place, the measure of wealth ignores the important influence 
of the economic organization on welfare, exercised directly 
through the nature and conditions of work, not indirectly 
through the product. We noted also that in some views of 
welfare wealth was treated as a comparatively unimportant if 
not negligible factor. 

The objection to this inquiry that it was unnecessary we 



Wealth and Welfare — Business and Morality 435 

decided to be unfounded. The ground of the objection was 
that the economic organization, owing to freedom of enter- 
prise, was responsive to all changes in standards of taste 
and morals, so that the use of productive powers and the 
conditions of production must be the outcome and reflection 
of current conceptions of welfare. On examination we found 
that freedom of enterprise did not necessarily make the 
economic organization responsive, and that the tendency of 
freedom of enterprise was to make the organization and its 
products fall below the level of current standards; in any 
case the economic organization could not be the mere outcome 
of current conceptions of welfare, because the economic 
organization reacts on our conceprions of welfare, favoring 
the development of certain aims in life and t^pes of character, 
and discouraging others. The influence of the present 
economic system we found was strongly materialistic, in the 
sense that it encouraged reliance on external rather than 
internal sources of satisfaction. 

For the same reason, that the reaction of the economic 
organization on standards of taste and conduct, and there- 
fore on the whole conception of welfare, is one of the most 
important of the social aspects of business, we put aside 
another objection to our inquiry — the objection, namely, 
that any discussion of the relation of wealth to welfare, being 
an ethical inquiry, was irrelevant to Economics. There 
is, however, a more cogent reason for putting aside the latter 
objection to including a discussion of the relation of wealth 
to welfare in an outline of Economics. Study, at any rate 
economic study, is for acdon. The immediate object of 
economic action is wealth, but the ultimate object is welfare, 
to which wealth is a means. Unless therefore our economic 
study tells us to what extent and under what circumstances 
an addition to wealth is an addition to welfare, it will not 
help us much in attaining the object of our action. The 
definition of welfare would be an ethical inquir>', but we 



436 Economics for the General Reader 

have not attempted such a definition; all we have tried 
to do is to define wealth, and to show exactly what the 
measure of wealth does measure and what it does not. Study 
is for action, and without such an inquiry we should not 
discover the limits within which economic considerations 
may properly determine action. The practical justification 
of our procedure is that half the discussions of wealth are 
carried on at cross-purposes and lead to nothing, Just because 
the parties to them use the word wealth without distinguish- 
ing between its two senses of product and welfare. , ' 

This negative method of stating the relations of wealth 
and welfare was forced upon us by the necessity of avoiding 
in an economic inquiry the ethical question — the question 
of the nature of true welfare. Without committing our- 
selves to a discussion of that difficult and controversial ques- 
tion, however, we can state in a positive form the conclusions 
to which our inquiry points on the relation of wealth to wel- 
fare. !•- 

The Necessities of Physical Existence. — Wealth is a 
means to welfare ; not, according to most views of welfare, 
the only means, but an important means. It is a means to 
welfare in two ways : (i) some wealth is the indispensable 
condition of physical existence, and therefore the basis not 
only of health but of every intellectual and spiritual activity ; 
(2) any addition to wealth above that indispensable minimum 
is a means to welfare by increasing man's freedom. It is not 
necessary to define the minimum or to mark it off by a hard 
and fast line — it must be allowed to include something more 
than the bare means of sustaining physical existence — but 
the distinction is important. Without the minimum there 
can be no real freedom, in the sense of self-determination: 
untU it is won, the man's activities are all determined for 
him by his physical needs. And it must be secure, or the 
Hfe that rests upon it, however noble and far-reaching its 
activities, will be built upon an insecure foundation. The 



Wealth and Welfare — Business and Morality 437 

great service that the Industrial Revolution did was, by 
increasing man's powers of production, to put it within the 
power of society for the first time to guarantee to every man 
this minimum. So long as this minimum is insecure, the 
individual must always be liable to worry within and tyranny 
from without ; for this reason security is more important 
than any addition to wealth, for this reason the workers 
demand a State guarantee of security, in the form of " the 
right to work," in preference to any schemes, however 
generous, of profit-sharing. The distinction between this 
minimum and the surplus of wealth is implied in Christian 
teaching, which enjoins the relief of distress while deprecating 
the pursuit of wealth ; and there is nothing materialistic in 
making the security of this minimum for every member of 
society a chief aim in politics. 

Wealth and Freedom. — Beyond this minimum wealth 
serves welfare by increasing freedom or liberty. Liberty 
used to be conceived as freedom from external control, and 
in this sense it was the aim of the movement which swept 
away the old system of protection and many other restrictions 
on freedom of action in the nineteenth century ; when these 
had been swept away, the great majority of people were still 
not conscious of possessing liberty, and the old negative 
conception has given way to a positive conception, which is 
best expressed by the word " opportunity." Wealth gives 
liberty in this sense ; it increases opportunity, giving the 
possessor more choice in the use of his time and fuller means 
of self-determination or self-expression. A man with wealth 
enough to live without working is, we say, " independent " ; 
a person who has to rely on another for all wealth is that 
person's " dependent." The effect of an increase of wealth 
upon welfare may be neutralized by misuse or waste ; the 
increase must be balanced against any change for the worse 
in conditions of production, and allowance made for the in- 
direct effects which an increase in one person's wealth may 



438 Economics for the General Reader 

have upon other people's welfare. But the increase in 
opportunity remains ; there is a potential increase in welfare. 
The present age might be the richest of all the ages in welfare, 
as it is the richest in wealth. Perhaps it is ; if it is not, it 
is because it has mistaken the means for the end, and treated 
the increase of wealth as an end in itself, instead of controlling 
it and directing it in accordance with its general conception 
of welfare. 

VI 

" Business Is Business " and Economic Laws 

The Test of Economic Activities. — If the view of wealth we 
have reached is correct, the practical conclusion follows, that 
economic activities are subject to the ordinary rules of moral- 
ity, and the economic organization is to be judged by its 
conformity to the ordinary standards of morality. Moral 
rules and standards embody our conception of welfare, and 
wealth is only a means to welfare. The immediate end of 
economic activities is cheapness, the production of a maximum 
of wealth with a minimum of effort and sacrifice ; but wealth 
itself is wanted only as a means of welfare, so that economic 
activities must be accounted good or bad according as they 
promote or hinder not wealth merely but welfare. We can 
separate the economic aspect of a social problem for study; 
in the problem itself the moral and economic aspects are 
combined, and moral considerations are the decisive factor, 
because they embody our conception of the end to which all 
action is directed. To persist in an economic activity there- 
fore, or maintain an economic organization which is contrary 
to our moral sense, is to subordinate the end to the means, 
or, in other words, to sacrifice morality to cheapness. 

Moral Test of Business. — It is necessary to point this out, 
because it conflicts with a view of the relation of business to 
moral rules and standards, which is commonly held and not 



Wealth and Welfare — Business and Morality 439 

infrequently avowed. Put baldly, the view is that business 
is something outside morality, a department of life in which 
the ordinary rules of morality have no validity. The view, 
however, is seldom put baldly ; more frequently it is expressed 
in the phrase " Business Is business," and in that form is used 
to condone conduct in business which would be considered 
dishonoring in any other relation of life. The view is not so 
much that business ought to be outside the ordinary rules of 
morality, as that it is, the economic organization being some- 
thing outside man's control, something for the principles of 
which he is not responsible. Just as in nature there is much 
that revolts the moral sense, but is beyond man's control, 
so the oppression, injustice, and " sharp practice " of business 
is supposed to be the inevitable outcome of a " natural " 
organization. In political discussion the view usually takes 
the form of an appeal to certain " natural " or " immutable " 
" laws of political economy," which are supposed to render 
futile any effort to moralize the economic organization by 
direct social action. 

Origin of Present View. — It is not difficult to understand 
how such a view arises. The self-interest of the people who 
profit by the present organization unconsciously inclines them 
to it. The unconscious identification of wealth and welfare 
which makes people seek wealth for its own sake lends sup- 
port to the view ; it leads people to regard the steady increase 
of wealth as a complete justification of the organization. The 
belief which we have already examined, that the economic 
organization under free enterprise responds to every change 
in our standards, and therefore automatically conforms to 
them, leads many people to ignore the problem of moralizing 
industry and prevents any protest against the view in ques- 
tion. The chief ground of it, however, is the helplessness of 
the individual in the face of the evils of the economic organiza- 
tion. Moral responsibility is personal, the economic organiza- 
tion and its evils are social. The old-fashioned duties of 



44© Economics for the General Reader 

charity and probity, that were adequate to a simpler economic 
organization, are apparently useless in the complex organiza- 
tion of to-day. The individual is part of a system that controls 
him ; competition, the fear of losing one's place in the struggle, 
compels all to toe the same Une of conduct, and an excess of 
scruple brings ruin ; " things are in the saddle and ride man- 
kind." 

Inadequacy of Free Enterprise. — The power of free enter- 
prise to bring the economic organization into conformity with 
current morality we have seen to be an illusion ; on the con- 
trary, if society does not impose its standards of taste and 
conduct on industry, industry will impose its standards on 
society. The idea that the economic organization is beyond 
control has even less foundation, being due to confusion of 
thought on the nature of what are called " economic laws " 
and' on the relation of the economic organization to these 
laws. When the " immutable laws of political economy " 
are used as an argument against any proposal, the impression 
conveyed is that these laws are at one and the same time 
like na;tural laws, and therefore beyond human control, and 
like moral or statute law, and therefore not to be disobeyed ; 
the suggestion intended is that the proposed reform is both 
futile and wicked. 

Relative Character of Economic Laws. — The " immu- 
tability "of economic laws varies; the phrase is applied in- 
discriminately to all the general tendencies that study dis- 
covers in the economic organization, and these by no means 
all belong to the same order. Some are tendencies peculiar 
to the present system of free enterprise, which will cease to 
operate if the system is changed. The so-called " law of 
monopoly price " is an example ; under private enterprise, 
monopoKsts tend to fix price and output at the level which 
gives them the biggest return of receipts over costs on the 
total output. Abolish private enterprise in monopolies, and 
you aboHsh the condition on which the " law " depends ; the 



Wealth and Welfare — Business and Morality 441 

State will tend to make the price as low and the output as 
large as is possible without actual loss. The " law of com- 
parative cost " is another example ; if trade is free, nations 
will tend to exchange with each other the products of those 
industries for which they have the greatest relative advantages, 
irrespective of actual cost of production. But this " law " 
does not make protection impossible ; protection, by abolish- 
ing free exchange, introduces a new condition. The great 
law of supply and demand belongs to the same order. Under 
free enterprise value depends on supply and demand ; a 
rise in value stimulates supply and checks demand ; a fall in 
value checks supply and stimulates demand. But this law 
does not prevent the State from fixing prices if it wants 
to. If it confines its interference with free enterprise to 
the fixing of prices, the law will still operate ; supply and 
demand will adjust themselves to the prices fixed by the 
State. So also with the more important case of fixing the 
price of labor. When the State fixes a legal minimum wage it 
compels no one to employ any worker whose contribution to 
the firm's output is worth less than the amount of the wage, it 
only prevents the employer from paying less to the worker 
whose contribution is worth it ; it deliberately prefers to 
support in some other way those workers who cannot, earn 
the minimmn and to dispense with those industries that caimot 
pay it. If the State wishes, however, it can abolish freedom 
of enterprise in an industry altogether, in which case the law 
no longer holds good ; in the case of miHtary service in a con- 
script country, supply and demand have nothing to do with 
the wages of the soldier. 

Some economic laws, however, are analogous to natural 
laws in being beyond human control ; but the fact that they 
are unalterable does not make the organization in which we 
discover them unalterable. The law of diminishing returns 
in agriculture is immutable ; but that does not prevent society, 
if it wishes, from substituting small for large holdings, or 



442 Economics for the General Reader 

public for private ownership of land. The tendency in certain 
manufactures to decreasing cost of production as the scale of 
production increases operates independently of the system of 
control of production ; hence the organization of those manu- 
factures can change from private firm to corporation, and 
from corporation to trust or municipal ownership without 
the " law " offering any obstacle. These unalterable " laws " 
of economics are all based on tendencies of physical nature or 
himian psychology ; they are not principles of organization ; 
they condition the economic organization, they do not deter- 
mine it in detail. Any system that is to work must take 
account of them and adapt itself to them ; but within these 
limits human ingenuity can exercise itself and devise any 
number of organizations. In the present economic system 
we discover many different principles of organization in the 
production and the distribution of wealth co-existing, and 
none of them seeking to ignore any " law." The laws of 
political economy prevent change in the economic organization 
no more than the laws of gravity, by which a stone released 
in space will fall, prevent us from building an arch, or the 
fact that the specific gravity of iron is greater than that of 
water prevents us from constructing an iron ship that will 
float. 

VII 

The Moralization of the Economic Organization 

Controlling the Economic Process. — The helplessness of 
the individual in the face of the evils of the present economic 
system is not then due to anything " natural " or " immu- 
table " in the system itself. The system is the creation of 
man, and man is responsible for it ; if it were really out of his 
control, it would be his duty at any sacrifice of wealth to 
destroy it and to substitute a system he could control. The 
belief that the economic organization is determined by 



Wealth and Welfare — Business and Morality 443 

certain natural laws and cannot be changed is a survival from 
the period of orthodox laissez /aire. People often think that 
a thing is impossible when they do not want to try to do it, 
and go on saying that it is impossible after it has been tried 
and done. The possibility of changing the economic organiza- 
tion is proved by the changes that have been effected in it. 
The modifications introduced have been conscious attempts to 
bring the economic organization into conformity with our 
moral ideas, and much has been done to moralize the economic 
system. The methods adopted were the obvious methods, 
and can be used to carry the moralizing process further. 

Possibilities of State Control. — If society discriminates 
between different kinds of wealth, regarding some as more 
important and some as less important for welfare, the State 
can give effect to that discrimination. It can supply the 
important forms itself, charging the cost in taxes, as it does 
education and armaments. It can " socialize consumption " 
by offering certain kinds of wealth for common use, again at 
the expense of the taxes — as it does in the case of pictures 
in picture galleries, recreation grounds in parks, fine archi- 
tecture in public buildings. It can subsidize forms of wealth 
which private enterprise neglects, as classical drama and 
opera are subsidized on the Continent. If society dis- 
criminates between trades and occupations, to this dis- 
crimination also the State can give effect. It can protect 
those trades which it considers most important, as Germany 
has protected its steel industry and its agriculture ; it can offer 
indirect subsidies, as most Governments do to agriculture; 
it can adapt its educational system to encouraging the occupa- 
tions it favors, and discouraging those it regards with dis- 
favor ; it can place restrictions on the trades it regards 
as liable to abuse, as restrictions are placed on the sale of 
drink; it can withhold its protection from contracts, as 
it does from gambling contracts. Similarly, society can 
give effect to any principles it may reach on the value of 



444 Economics for the General Reader 

different types of economic organization by prohibiting 
undesirable forms, as emplojnnent of children in factories 
is prohibited, and by imposing limits on freedom of enter- 
prise, to prevent underpayment, overwork, and unhealthy 
conditions. It can diffuse control and responsibility in 
economic life by encouraging those occupations, like agri- 
culture, in which small-scale enterprise is economical, by 
assisting experiments in cooperation, and by intrusting the 
regulation of conditions to trade-associations — which is the 
claim of syndicalism, a claim conceded to the medical pro- 
fession, the legal profession, and the university teaching 
profession. It can promote equality, or at any rate check 
the growing inequality of wealth, by taxation and by laws 
of inheritance. Such a poHcy may involve some check to 
the growth of wealth ; it may reduce the total of wealth, 
although it has not done so hitherto ; but the aim of the 
community is welfare, not wealth, and if it decides that 
welfare can be increased at the expense of some wealth, it 
has the power to act on its decision. Protection, for example, 
usually involves a reduction in wealth ; it is not therefore 
necessarily bad : whether it is bad or not depends on its other 
effects. 

Business and Individual Conduct. — Ethical considerations 
cannot be excluded from economic activities. Business, 
although we can separate it from the rest of conduct for the 
purpose of study, remains a part of conduct, and as such is 
subject to the general rules of conduct. A morality that 
admitted so large an exception as business to its rules would 
be no moraHty. The helplessness of the individual, acting 
as an individual, in the face of the evils of the present economic 
system, does not absolve him of responsibility for them. He 
benefits by the system : the system is capable of change, and 
the methods by which it can be changed are known. What 
his individual helplessness points to is the necessity of social 
action, where individual action is inadequate, and his personal 



Wealth and Welfare — Business and Morality 445 

responsibility is discharged only when he has cooperated in 
such social action. 

Doubts of the need and possibility of bringing the economic 
organization of society into conformity with society's general 
conception of welfare are not the only obstacle to the attempt ; 
a greater obstacle is the divergent conceptions of weKare 
that are held, not only by different churches and parties, but 
even within the same church or party. Ruskin felt this so 
strongly that he thought the primary business of political 
economy should be to answer the ethical question, *' What is 
Welfare? " or " Wealth," as he called it. With that diver- 
gence we are not concerned, except to note that it is only 
in hght of such a general conception that we can value and 
judge competing types of economic organization and different 
objects of economic activity ; and to remember that while 
we can separate the economic and the ethical aspects of a 
problem for the purpose of study in the problem itself they 
are combined — we cannot separate them for action. 



INDEX 



Accumulation of capital, conditions requi- 
site for, 04-97. 

Advertising, a form of association or co- 
operation, 1 3 1 ; as a means of controlling 
the consumer, 372. 

Agricultural cooperation in Europe, 118- 
119. 

Agriculture, obstacles to large-scale pro- 
duction found in certain kinds of, 33 ; 
law of diminishing returns in, 330-333. 
441 ; reason for attaching special im- 
portance to small holdings, 412-413. 

Anticipation of demand, nature of, 64-65 ; 
involved character of, 65-66; relation 
of production to, 66-67 ; utility of 
banking and credit system in financing 
production in, 188-194; unemployment 
and overproduction traceable to im- 
perfect, 233-236. 

Aristotle, on slaves as "living tools," 417. 

Art, compared with wealth as an index of 
greatness, 420. 

Artificial scarcity and rent, 349-350. 

As signals, an example of inconvertible 
paper currency, 164. 

Association, relation between competition 
and, iii-iis; forms of, found in trade 
unions, cooperative societies, employers' 
associations, public ownership, and 
public aid and advertising, 115-122. 

Averages, use of, in compiling index num- 
bers of price levels, 197. 

Balance of trade, and the level of prices, 
209-213. 

Bank account, use of the, 172-173; func- 
tioning of the, 177; methods of obtain- 
ing accounts, 177-178. 

Banking and credit, 169 £F.; canceling of 
indebtedness by use of credit instru- 
ments, 169; operation of banking sys- 
tems, 173-175; creation of credit by 



banks, 177-180; the cash reserve, 180- 
187; social utility of credit system, 
188-193 ; summary of need for banking 
and credit system and of function of, 
193-194- 

Barter, as a method of exchange, 21, 153- 
154- 

BiUs of exchange, use of, as paper cur- 
rency, 167-168; as an instrument of 
cancellation, 175-176. 

Bimetallism, 159-161. 

Boycott, use of the, by trusts, 150-151. 

Brassage, defined, 157. 

Bullion certificates, class of paper currency 
called, 164. 

Business, economics the study of, in its 
social aspect, i ; an example of modem, 
1-3; and morality, 418 S.; the moral 
test of, 438-439; and individual con- 
duct, 444-445. 

"Business is business," implications of 
phrase, 439. 

Business men, as organizers of modem 
industry, 47-48. 

Business organization and specialization, 
29-31. 

Buying, associations for, 115; restricting 
competition in, 117. 

Call loans, meaning of, 186. 

Cancellation of indebtedness by use of 
credit instruments, 169-177. 

Capital, dealing on insufficient, an ille- 
gitimate form of speculation, 84-85 ; 
functions of, in modem industry and 
commerce, 92-94; conditions requisite 
for accumulation of, 94-97 ; different 
types of organization for applying, 97- 
104; the market for, 105-106; income 
and, 2 1 8-221; expense of, 222-223; 
supply and demand applied to, 324-325: 
productivity of, the chief influence that 



447 



448 



Index 



affects the demand for loans and so the 
rate of interest, 326-327; exploitation 
theory of, 327. 

Captains of industry, function of, 47-48. 

Carnegie, Andrew, and the Steel Trust, 147. 

Cash reserve of banks, reason for, 1 80-1 81 ; 
conflict of motives in management of, 
181-182; regulation of, 182; in the 
United States, 182-183; in England, 
183-186; methods of strengthening, 
186-187. 

Charity, compromise between private 
enterprise and State action in adminis- 
tration of, 364-365. 

Checks, use of, as paper currency, 166-167. 

Circulation of money, relation between 
rapidity of, and level of prices, 202-203. 

Circulation of wealth, cause of, 221. See 
Wealth. 

Class prejudice, influence of, in appoint- 
ment of organizers of industry and com- 
merce, 60-61 ; influence of, upon oppor- 
timity for entrance to industrial and 
commercial occupations, 311. 

Clearing house, a form of employers' 
association, 119; method of operation 
of, 179. 

Clearing of checks by banks, 174. 

Coinage of money, 156-157; freedom of, 
158-159. 

Collateral security, meaning of, 193. 

Combination, as a means of eliminating 
risk, 89-90; purposes of, 115; nature 
of trade unions, 11 6-1 17; the coopera- 
tive movement, 117-118; agricultural 
cooperation in Europe, 11 8-1 19; em- 
ployers' associations, 1 19-120; monop- 
oly and, 123 ff. ; the tendency to 
monopolistic, 137 ff. ; difficulties of, 
140-141 ; extent of, 141-143 ; vertical 
combination, 152; cases of, caUing for 
State supersession of private enterprise, 
377-378. See also Monopoly. 

Common stock and preferred stock, 99-100. 

Community of interests created by compe- 
tition, 112-115. 

Comparative cost, law of, 204-207. 

Competition, nature and scope of, 107-110 ; 
in buying, no; effect of, on price, in ; 
conflicting and common interests arising 
from, 111-115; associations to restrict, 
in selling, 115-117; advantage of 



monopoly over, in economy, 125-127; 
self-destructive to railways, 128-129; 
force of potential, in limiting power of 
trusts over prices, 147—148 ; elimination 
of wastes of, by monopolistic combina- 
tion, 149-150; effect of, on overproduc- 
tion, 235-236; influence of, on value, 
262-264; as a regulator of production 
and distribution, 359-360; assumption 
of siurvival of socially fittest vmder, 371, 
374-376. 

Complexity of economics, 13-14. 

Concentration, specialization and, in in- 
dustry, 31; advantages and weaknesses 
of, 31-33; obstacles to, 33-34. 

Consumers, State interference in behalf of, 
361-362 ; ways of influencing, 372-373. 

Consumers' association. See Cooperative 
movement. 

Consiunption loans, 323-324. 

Contracts, use of, for shifting speculative 
risks, 73-78; dependence of economic 
relations upon, 358. 

Cooperation of buyers and of sellers, 115; 
of trade unions, 116-117; other types 
of, 1 17-122; employers' associations, 
1 1 9-1 20; vmemployment due to im- 
perfect, between speciaUsts, 229-232. 

Cooperative movement, the, 56-57 ; prog- 
ress and ideals of, in Great Britain, 117 ; 
types of cooperation, 11 7-1 18; agri- 
cultural cooperation, 118-119; im- 
portance of, on account of moral effects, 
413- 

Cooperative xmdertakings, advantages of, 
regarded as a means of applying capital, 
103. 

Coordination of specialists, necessity for, 
46-47; an unconscious process, 47; 
viewed as itself a specialty, 47-48; 
functions of the middleman in process 
of, 48-49. 

Corners, monopolistic combinations called, 
138. 

Corporate securities, 99-100. 

Corporation, development of the, 56-57; 
specialization in organization found in 
the, 62-63; advantages and disadvan- 
tages of the, as a means of applying 
capital, 98-102; special applications of 
corporate form, 102 ; limits of corporate 
enterprise, 103-104. 



Index 



449 



Cost of production, various interpretations 
of term, 253-254; value implied in, 
264-265. 

Cost of production theory of value, 245, 
250-256 ; historical background of, 273. 

Costs, analysis of meaning of word, 256; 
decreasing, increasing, and constant, 
256-259; complicated nature of, 259- 
261. 

Credit, banking and, 169-194 ; part played 
by, in trade fluctuations, 240. 

Credit extension by banks, 179-180. 

Credit instruments, canceling of indebted- 
ness by the use of, 169-177. 

Credit notes, 165. 

Cyclical trade fluctuations, 236. 

Definiteness of economic values, influence 
of, on tendency to materiahsm, 426-428. 

Demand, relation between risk and the 
nature of, 90-91 ; results of imperfect 
anticipation of, 233-236. See Supply 
and demand. 

Demand deposits at banks, 178. 

Demand loans, 186. 

Differential advantages and profits, 316- 
317- 

Diminishing returns, law of, 330-334. 

Discounting, use of, in banking and credit 
system, 191-193. 

Distribution, inequality in, and saving, 
96-97 ; influence of, on welfare, 401- 
404 ; influence of method of, on tendency 
of economic system to materialism, 429- 
430. 

Division of labor, the, 21 ff. ; forms of, 23- 
24 ; machinery the result of, 24-25 ; 
promoted by machinery, 25-26 ; the 
localization of industries, 27-31 ; large- 
scale production, and the limits of 
specialization, 31-37 ; evils of specializa- 
tion, 38-45. 

Drafts, or bills of exchange, 167-168. 

Economic activities, the test of, 438. 

Economic evils, as symptoms, 421-422; 
fundamental character of, 422-423. 

Economic laws, character of, 438-442. 

Economic organization, the State and the, 

355 ff- ; private property and freedom of 

enterprise, 355-360; regulation and 

supersession of freedom of enterprise by 

3G 



the State, 360-365 ; taxation, 365-369 ; 
assumptions of existing system, 370- 
371; assumption of rational self- 
interest, 372-374; assumption that 
competition leads to survival of the 
fittest, 374-376 ; assumption that wealth 
will be associated with social service, 
377-383 ; assumption that market value 
corresponds with social value and is an 
indicator for production to follow, 371, 
383-387 ; dlGBculties created by laissez- 
faire poUcy, 387-388. 

Economics, defined, i ; account of a busi- 
ness transaction to show subject matter 
of, 1-3 ; interest and importance of, 4-5 ; 
relation between study of, and business 
exp)erience, 6-7 ; reasons for necessity of 
supplementing individual experience by, 
7-8 ; reason for desirability of study of, 
by business men, 8-9; the method of, 
9-13 ; complexity of, 13-14 ; held to 
be a science, 14-15; relation of, to 
other social sciences, 15-17; object of, 
is explanation solely, 1 7 ; temporary 
character of conclusions of, 17-19; 
justification of, 19-20; question as to 
whether welfare is a matter of, 420-421. 

Economic theorj', nature of, 9-10. 

Economic worth, use of term, 300-301. 

Economies of monopolistic combinations, 
148-150. 

Economy of paper substitutes for metallic 
money, 169. 

Education, a case of State supersession of 
private enterprise, 363-364. 

Efficiency, as a substitute term for produc- 
tivity, 300; what is meant by, 376; 
sacrifice of worker's humanity to, 414. 

Employers' associations, 1 19-120. 

Employment, conditions of, and wages, 
281-282. 

England, banking laws in, 183-186. 

Entrepreneur, meaning of term, 67. 

Equality, importance of, as basic principle 
of tax system, 367. 

Equality of opportunity, importance of, to 
assumption that competition leads to 
survival of the fittest, 374-376. 

Ethics and economics, 15-17. 420-425. 

Exchange, division of labor and, 22-23; 
two methods of, 153-154; variety of 
media of, 154; influence on, of banking 



45° 



Index 



and credit system, i88; effect of fre- 
quency of, on level of prices, 201-202. 

Exchanges, foreign, 204-213. 

Experience, business, relation between 
economic study and, 6-7; instinctive 
nature of, 7 ; limitations of, 7-8. 

Exploitation theory of capital, 327. 

Factory legislation, as State interference 
with freedom of enterprise, 361. 

Factory manager, oflSce of the, 50. 

Faculty, taxation according to, 368. 

Family wage, the, 282. 

Federal reserve system, the, 182-183. 

Fertility, influence of, on rent, 329-330. 

Feudalism, advantage of, in way of secur- 
ing duties in exchange for property, 379- 
380. 

Fiat money, 163. 

Financiers, function of, as dealers in 
capital, 105. 

Fiscal policy, economic rent and, 353-354. 

Fitness, what is meant by, in speaking of 
survival of the fittest, 375-376. 

Fluctuations in trade, causes of, 236-241. 

Flyer, the, an illegitimate form of specula- 
tion, 84. 

Ford, Henry, an example of exceptional 
ability, 147. 

Foreign exchanges, 204-213. 

Forms of division of labor, 23-24. 

Franchise, function of the, 131. 

Freedom, increase of, by wealth, 437-438. 

Freedom of coinage, 158-159. 

Free enterprise, meaning of, 57; merits 
and defects of system of, 58-63; in- 
stitution on which existing social system 
is based, 357; regulation of, by the 
State, 360-365 ; reasons for restrictions 
on, 423-425; inadequacy of, to bring 
the economic organization into con- 
formity with current morality, 440. 

Futures, markets for dealing in, 78-79; 
process of buying, 79-80; selling, 80- 
82; professional dealers in, 82; an 
encouragement to illegitimate specula- 
tion, 82-83. 

Gambling, dealing in futures and, 82-83. 

See Speculation, illegitimate. 
George, Henry, single-tax theory of, 351- 

353- 



Germany, monopolistic combinations in, 
140. 

Gold, influence of production of, on level 
of prices, 198-199; difference between, 
and other commodities, 199; indirect 
influence of changes in supply of, 199- 
201 ; relative importance of changes in 
production of, 201 ; transfer of, necessary 
when imports and exports do not baljmce, 
208-209; effect of movements of, 211- 
213. 

"Gold-points," explanation of, 211. 

Gresham's Law, 161-162. 

Habit, a force which keeps men industrial 
slaves, 42. 

Hadley, A. T., quoted on drawbacks to 
large-scale production, 32. 

Hobson, J. A., Evolution of Modern Capital- 
ism, cited on price agreements, 138. 

Human beings, surpassed by inanimate 
machines as productive mechanism, 24- 

27- 

Hyndman, exponent of Marx's labor theory 
of value, quoted, 249. 

Idle, effect of use of, on national income, 

225-226. 
Imports, paid for by exports, 207-209. 
Income, and wealth, 214-215 ; and capital, 

218-221; the national, 223-226; wages 

and, 279-283 ; relation between taxation 

and, 367-368. 
Incomes, estimating a country's wealth 

by adding together, 392. 
Increasing cost, law of, 330-334. 
Index numbers for indicating change in 

level of prices, 196-197. 
Individual business, the, as a means of 

applying capital, 97-98. 
Individual conduct, business and, 444- 

445- 

Individual insecurity, materialistic tend- 
ency of economic system accentuated 
by, 428-429. 

Industrial Revolution, power machinery 
the basis of the, 26-27 1 modem problem 
of production created by, rather than 
solved, 417. 

Industries, localization of, 27-31. 

Inequality in distribution, saving and, 
96-97 ; welfare and, 401-402. 



Index 



451 



Inequality of opportunity, influence of, on 
wages, 309-311. 

Inequality of wealth, as the cause of in- 
equality of opportunity, 61-62. 

Inheritance, a method of acquiring wealth 
without rendering social service, 379-380. 

Initiative, destruction of, by division of 
labor, 41-42. 

Instinctive nature of experience, 7. 

Insurance, nature of, as a device for meet- 
ing risks, 88-89. 

Interest, distinction between profits and, 
314; variation in rate of, with amount 
of risk, 320; the basis of, 321 ; reasons 
for payment of, 321-324; what deter- 
mines rate of, 324-327; rent elements 
in, 34S-3SO. 

International trade, 204; methods of 
financing, 209-210. 

Intertrade dependence, 237. 

Investment and trust companies, as an 
organized market for capital, 105. 

Investments, remunerative, a condition 
requisite for saving, 95-96; rent ele- 
ment in fixed, 345-347- 

Jevons, W. S., explanation of trade fluc- 
tuations by, 239-240. 

Joint-stock companies, 99-100. 

Justice, most important principle for basis 
of a tax system, 367. 

Rartel, German monopolistic combina- 
tion, 140. 

Knowledge, advantage of specialized, to 
the middleman, 48-53, 93. 

Labor, division of, 21 £f. ; cheapness of, an 
influence in localization of industries, 
28; exjDcnse of, 222-223 ; what is meant 
by, under labor theory of value, 247 ; 
inseparability of the worker and his, 
285-286 ; perishability of, 286-287 ; 
purpose of the trade union, 287-288; 
variation in supply of different kinds of, 
309-310 ; theory of capital as exploited, 
327- 

Labor cost, wages and, 283-285. 

Labor-saving machinery, effect of, 225. 

Labor theory of value, 245-250 ; historical 
background of, 272-273. 

Labor unions. See Trade unions. 



Laborers, evils to, of division of labor, 39- 
40. 

Laissez-faire policy, meaning of, 57 ; merits 
and defects of, 58-63 ; difficulties created 
by, 387-388; the broader implications 
of policy of, 423-425. See Free enter- 
prise. 

Land, speculative dealing in, 87-88; the 
payment of rent for, 328; no-rent land, 
328-329; influence of fertility, 329-330; 
the law of diminishing returns or in- 
creasing cost, 330-334; Ricardo's con- 
cept of rent, versus the popular concept, 
337-338; effect of absence of no-rent 
land, 338-339 ; productivity as a basis 
for rent calculation, 339-340 ; the single- 
tax proposition, 351-353. 

Large-scale production, causes leading up 
to, 31; advantages of, 31-32; draw- 
backs to, 32-33; obstacles to, 33-34; 
reasons for survival of the small firm, 
35-37 ; limits on successful conduct of, 
104. 

Legal tender, what constitutes, 157-158. 

Level of prices, significance of term, 195- 
196; use of index numbers for measur- 
ing, 196-197; effects of changes in, 
197-198; causes of changes in, 198- 
203 ; relation of money value to, 203 ; 
the law of comparative cost, 204-207 ; 
imports paid for by exports, 207-209; 
balance of trade and, 209-213. 

Liberty, increase of, by wealth, 437-438. 

Limited liability corporations, 99-100. 

Loans, true nature of, 321; use of, in 
production, 321-323 ; consumption, 323- 
324; effect of demand for, on rate of 
interest, 326-327. 

Localization of industries, the basis of, 
27-28; advantages of, 28-29 ; effect of, 
on growth of allied trades, 29 ; how the 
middleman is essential to, 52-53; favor- 
able to "monopolistic combination, 143- 
144. 

Machinery, relation of, to division of labor, 

24-26 ; relation between, and specialized 

labor, 44-45. 
Management, profits viewed as the wages 

of. 314-315- 
Manipulation of prices, an illegitimate 

form of speculation, 85. 



452 



Index 



Marginal productivity, 296-297; relation 
of supply to, 297. 

Marginal utility theory of value, 245, 269- 
272. 

Market, specialization limited by extent 
of the, 34-35; influence of means of 
transport on state of, 37; influence of, 
on speculative risks, 76; for capital, 
105-106. 

Markets, accessibility of, an influence in 
localization of industries, 28; terminal, 
for dealing in futures, 78-83. 

Market value, followed as a guide by 
production, 276-277, 358-359; produc- 
tivity and, 299—300; the assumption 
that market value corresponds with 
social value and is an indicator for 
production to follow, 371, 383-387 ; 
inadequacy of, as a social guide, 385- 
387; inadequacy of, as a measure of 
wealth, 399-400. 

Marx, Karl, labor theory of value as set 
forth by, 245-246, 248-249. 

MateriaUsm, reaction of economic or- 
ganization toward, 425-426; tendency 
toward, of present-day economic in- 
fluences, 426 ff . ; influence of definiteness 
of economic values, 426-428; influence 
of individual insecurity, 428-429; in- 
fluence of method of distribution, 429- 

430- 

Middleman, functions of the, 48-49; a 
necessary Unk between manufacturer 
and consumer, 49-50 ; services rendered 
by, 50-51; nature of "toll" of, 51-52; 
essential to locaUzation, 52-53; func- 
tion of, as a risk-taker, 74-76 ; function 
of the professional future dealer, 82. 

Mill, J. S., quoted on theories of value, 
245; on cost of production, 250; on 
wages fund theory of wages, 291, 292- 

293- 
Money, use of, a device to facilitate ex- 
change, 23; and coinage, 153-158; 
the single standard, 158-161 ; Gresham's 
Law, 1 61-162; paper currency, 163- 
168; economy of paper substitutes, 
169; change in value of, shown by 
change in level of prices, 195-196; 
causes of changes in purchasing power 
of, 198-203; relation of value of, to 
price level, 203 ; as measure of value, 



243 ; use of, as a measure of exchange- 
values of forms of wealth, 391-392. 

Money market, the, 105 ; substitution of 
the, for gold as a medium of exchange, 
176. 

Monopoly, causes leading up to, 123; 
definition of, 123-124; public utility 
monopolies, 124-125; economy of, 125- 
127; railways as monopolies, 127-129; 
methods of regulating monopolistic in- 
dustries, 129-135; private business 
monopolies, 137-138; corners, 138; 
price agreements, 138-139; trusts, 139- 
140 ; difficulties and extent of combina- 
tion, 140-143; conditions favorable to 
monopolistic combination, 143-146 ; dif- 
ficulties of monopolistic combination, 
146-148; advantages of monop)olistic 
combination, 148-151 ; influence of, on 
value, 262-264 ; relation between supply 
and demand and, 277-278; effect of, 
on profits, 317-318; State interference 
with, 362-363 ; State supersession of 
private enterprise in case of technical, 
377-378. 

Monopoly price, law of, 440-441. 

Morality, business and, 418-445. 

Moral standards, relation between the 
economic organization and, 420-425; 
reaction of the economic organization 
on, 425-430. 

Municipal enterprises, advantages of, as a 
means of applying capital, 103. 

Municipal ownership, importance of, as a 
type of association of consimiers, 120- 
121. 

National income, the, 223-226; flexibility 
of, 226-227; influence on wages of 
volume of the, 308-309. 

National ownership, an important type of 
association of consumers, 1 20-1 21. 

Opportimity, inequality of, due to in- 
equality "of wealth, 61-62 ; influence of 
inequality of, on wages, 309-311. 

Organization, different types of, for apply- 
ing capital, 97-104. 

Organizers of production, necessity for, 
53-54; importance of efficiency of, 54- 
55 ; selection of, 55-56 ; usually self- 
appointed, 57; defects of competitive 



Index 



453 



selection of, 58-50; hereditar>' selec- 
tion of, 60; influence of class prejudice 
in appointment of, 60-61. 

Overcapitalization of combinations, 142. 

Overproduction, unemployment and, 
229 ff. ; what is meant by, 234-235. 

Paper currency, inconvertible, 163-164; 
evils of an inconvertible, 164; bullion 
certificates, 164; the credit note, 165; 
checks, 165-166; bills of exchange, 167- 
168; economy effected by use of, 169. 

Personality, purpose of work to develop, 
413-414- 

Phrases based on wealth standards, 433. 

Piece wages, 279-280. 

Politics, relation of economics to ethics 
and, 15-17. 

Population, influence on national income 
of increase of, 226. 

Potential competition, power of trusts over 
prices Umited by, 147-148. 

Power, cheapness of, an influence in local- 
ization of industries, 28. 

Practice, relation of theory to, 11-12. 

Precious metals, reason for use of, as 
money, 155-156; characteristics of, 156. 

Press associations, a form of employers' 
association, 120. 

Price, effect of competition on, u i ; defini- 
tion of, 19s; importance of, as affecting 
fluctuations in trade, 239; relation be- 
tween value and, 243-245. 

Price agreements, monopolistic combina- 
tions by means of, 138-139. 

Price differentiation, a weapon of the 
trusts, 151. 

Price-fixing, by the State, 132-133; as- 
sociations for, 139. 

Price level. See Level of prices. 

Prices, influence of speculation on, 69 ; 
manipulation of, an illegitimate form of 
speculation, 85-86; relation between 
rent and, 334-335- 

Producer, State interference and the, 360- 
361. 

Product, wealth as, 389-393 ; influence of 
kind of, on welfare, 404-406. 

Production, the organization of, 46 ff. ; 
methods of appointing organizers of, 
53-57 ; effects of free enterprise on 
flexibility in, 58; as a whole carried on 



in anticipation of demand, 64-67 ; in- 
fluence on, of banking and credit system, 
189; wealth and, 214-217; constancy 
of demand for the factors of, 223; 
lack of mobihty in factors of, resulting 
in defective codf)eration, 232 ; market 
value followed as a guide by, 276-277, 
358-359; use of loans in, 312-323; 
rent and cost of, 334-337 ; rent as a 
stimulus to, 350-351; competition the 
regulator of, 35^360; the assumption 
that market value is a satisfactory 
indicator to follow, 371, 383-384. 

Productive agents, complementary re- 
lationship of, 341-342. 

Productivity, discussion of the word, 299- 
300 ; substitute terms for, 300-301 ; 
as a basis for rent calculation, 339-340. 

Productivity theories of wages, 293-301. 

Professions, regulation of, by the State, 
361-362. 

Profits, hmitation of, as a means of control 
of monopolized industries, 131-133; 
basis of, 295 ; distinction between in- 
terest and, 314; as the wages of man- 
agement, 314-315; the payment for 
undertaking risks, 315; variability of, 
315-316; differential advantages and, 
316-317; effect of monofwly on, 317- 
318; statement of the three important 
elements in, 318; variable significance 
of the elements in, 319-320; rent ele- 
ments in, 345-350- 

Progressive taxation, 367. 

Property, security of, a condition requisite 
for saving, 95 ; private, the institution 
on which present social system is based, 
357; and service, 371, 377-383- 

Public aid and advertising, a type of 
association, 121. 

Public ownership, 120-121; and private 
operation, 133; and public opieration, 
134; extension of, 134-135. 

Public utility monopwlies, 124-125. 

Public utility services, a case of State 
supersession of private enterprise, 363. 

Pure food laws, a form of State inter- 
ference with freedom of enterprise, 362. 

Railways, as monopolies, 127 ; compxtition 
self-destructive to, 128-129; limitation 
of profits on, 131-133. 



454 



Index 



Rapidity of drcxilation, effect of, on level 
of prices, 202-203. 

Rates of exchange, 210-21 1. 

Raw materials, accessibility of, an in- 
fluence in localization of industries, 28. 

Rebates, use of, by trusts, 151. 

Red tape, evils of, 33. 

Religion, compared with wealth as an 
index of the age or country's temper, 
420. 

Rent, viewed simply as one kind of profit, 
317; the Ricardian theory of, 328-330; 
law of diminishing returns or increasing 
cost, 330-334; relation between prices 
and, 334-335; social importance of, 
336^337; difference between popular 
meaning of word and meaning given it 
by economists, 337; appUcation of 
Ricardian theory to actual conditions, 
337~340> elements of, in wages, 341- 
34S ; element in fixed investments, 345- 
347; significance of Ricardian theory, 
347~348; value output and, 348-349; 
artificial scarcity and, 349-350; social 
implications of Ricardian theory, 350 ff. ; 
as a stimulus to production, 350-351 ; 
economic, and fiscal policy, 353-354; 
viewed as wealth obtained without 
due exchange of social service, 380- 
381. 

Replacement of capital, necessity for, 220- 
221. 

Reserves. See Cash reserves. 

Ricardo, an exponent of the labor theory 
of value, 245-246, 248; theory of rent 
held by, 328-330; significance of theory 
of, 347-348 ; social importance of theory 
of, 350-354- 

Risk, elements of, introduced by specializa- 
tion, 42-43, 72-73 ; suggested methods of 
elimination, 73 ; elimination of, by con- 
tracts, 73-74 ; example to show distribu- 
tion of, 76-78; concentration of risk- 
taking by terminal markets for deaUng 
in futures, 78-83 ; insurance as a means 
of meeting, 88-89; elimination of, by 
combination, 89-90; and the nature of 
demand, 90-91 ; profits viewed as pay- 
ment for undertaking, 315 ; variation in 
interest rate due to, 320. 

Routine, waste and weakness of big con- 
cerns found in tendency to, 33. 



Saving, capital and, 94-95; security of 
property and remunerative investments 
conditions requisite for, 95-96; in- 
equality in distribution a consideration, 
96-97; reason of necessity for, 221; 
difference between spending and, 221- 
222; effect of rate of interest on, 325- 
326. 

Sciences, economics regarded as one of the, 
14-15; relation of economics to other 
social, 15-17. 

Security of property, a condition requisite 
for saving, 95. 

Seigniorage, defined, 157. 

Self-interest, assumption of, as a factor in 
present economic organization, 370-371, 
372-374. 

Selling, restricting competition in, 115-117. 

Service, property and, 371, 377-383. 

Shipping conferences, use of, by trusts, 151. 

Single standard of value, the, 158-161. 

Single tax, the, 351-352; objections to, 

352-353- 
Site value, a factor in calculation of rent, 

333-334- 

Small firms, reasons for survival of, 35-37. 

Smart, Distribution of Income, cited, 300. 

Smith, Adam, on the division of labor, 21 ; 
quoted on limiting of division of labor 
by extent of market, 34; on influence 
of means of transport on extent of the 
market, 37 ; on limits of corporate enter- 
prise, 103-104 ; an exponent of the labor 
theory of value, 245-246, 248; on rela- 
tion of the State to the economic organi- 
zation, 355-356 ; on taxing in proportion 
to income, 367. 

Socialism, inefficacy of, 418. 

Social power, wealth and, 403-404. 

Social service, wealth and, 371, 377-383. 

Social standards, significance of, to wealth 
and welfare, 402-403. 

Social utility of banking and credit system, 
188-194. 

Social viewpoint, importance of, 8-9. 

Specialization, economy of, 21-24; effect 
on concentration of industries in par- 
ticular localities, 27; opportimities for, 
afforded by localization of industries, 
28-29; business organization and, 29- 
31 ; and concentration, 31 ; obstacles 
to, 33-34; limited by extent of the 



Index 



455 



market, 34-35 ; reasons for survival of 
the small firm, 35-37 ; evils of, 38-45 ; 
necessity for coordination of specialists 
resulting from, 46-47 ; in organization 
found in the corporation, 62-63 ; two 
inevitable risks introduced by, 72-73; 
principle of, applied to dealers in the 
taking of risks, 75-76. 

SpeciaUzation of labor, promoted by use of 
machinery, 25. See Division of labor. 

Speculation, universality of, 67 ; nature 
of, 68; social effect of, 68; operation 
of, 68-69; influence of, on prices, 69; 
effect of erroneous forecasts, 69-70; 
necessity for, 70 ; relation to fluctuation 
in demand, 70-71; and fluctuating 
supply, 71-72; dealing in futures, 78- 
83; legitimate and illegitimate, 83-84; 
the "flyer," 84 ; with insuflBcient capital, 
84-85 ; manipulation of prices, 85-86 ; 
in Stock Exchange securities and in 
land, 86-88; attitude of the State 
toward, 88 ; effect of illegitimate, on 
trade fluctuations, 240-241. 

Speculative dealing, discussion of, 67-73. 

Spending and saving, 221-223. 

Standard of life, influence of, on wages, 
301 ff. ; subsistence theory and the, 
301-302 ; relative character of, 303-304 ; 
influence of conception of a, 304-307 ; 
permanence of conception of, 307. 

State, attitude of the, toward speculation 
on produce exchanges, 88; and the 
economic organization, 355 ff. ; inter- 
ference by the, with freedom of enter- 
prise, 360-361 ; possibilities of control 
of economic process by the, 443-444. 

Stock, common and preferred, defined, 99- 
100. 

Stock Exchange, speculative dealing in 
securities of, 86-88; function of, in 
relation to capital, 106. 

Subsistence theory of wages, 289-291. 

Substitutes, power of trusts over prices 
limited by, 147. 

Supply, meaning of, and influence in fixing 
value, 262 ; relation between utility and, 
268-269; relation of, to marginal 
productivity, 297 ; nature of, of labor, 
302-303. 

Supply and demand, relation between, 
227-228; misapplication of phrase, 



274 ; explanation of, 274-275 ; mutual 
relationship of value and of, 275 ; 
elasticity of, 275-276; monopoly and, 
277-278; applied to capital, 324-325. 
Syndicalism, significance of, 416. 

Tariff, influence of the, on formation of 
trusts, 145-146 ; one form of State inter- 
ference with freedom of enterprise, 362. 

Taxation, reason for, 365-366; character- 
istics of good system of, 366-367 ; po- 
litical principles to be used as a basis 
for, 367-368 ; why compromise is neces- 
sary in, 368-369. 

Theory, nature of economic, 9-10; rela- 
tion between practice and, 11-12; in- 
dividual presuppositions and, ia-13. 

Time deposits at banks, 178. 

Time wages and piece wages, 279-280. 

Token coinage, defined, 158. 

Trade, international, 204 ; conditions giv- 
ing rise to, 204-205 ; cyclical fluctuations 
in, 236-241. 

Trade unionism, purpose of, 116-117, 287- 
288; wages and, 285-288; view of, 
according to wages fund theory of 
wages, 293. 

Training, influence of, on wages, 310-311. 

Transport, influence of means of, in deter- 
mining extent of market, 37. 

Trusts, monopolistic combinations called, 
139-140; conditions favorable to, 143- 
146; State interference with, 362-363- 
See Monopoly. 

Unemployment and overproduction, causes 

of, 229-241. 
United States, banking regulations in, 

182-183. 
Utility, element of, under labor theory of 

value, 246 ; relation of, to value, 266- 

269; marginal utility theory of value, 

269-272. 

Value, of media of exchange, 1 54 ; im- 
portance of "intrinsic," 154-15S ; money 
as measure of, 155, 243; meaning of, 
242-243 ; relation of price and, 243-245 ; 
three theories of, 245 ; labor theory of, 
245-250; cost of production theory of, 
250-256; decreasing, increasing, and 
constant costs, 256-261 ; influence of 



456 



Index 



competition and monopoly on, 262-265 ; 
relation of utility to, 266-269 ; marginal 
utility theory of, 269-272; historical 
background of theories of, 272-273; 
the law of supply and demand, 273-275 ; 
mutual relationship of, and of supply 
and demand, 275; the automatic in- 
dicator which production follows, 276- 
277 ; assumption of correspondence be- 
tween market and social, 371, 383-384- 

Value output and rent, 348-349. 

Vertical combination of industries, 152. 

Volume of exchanges, effect of, on level of 
prices, 201-202. 

Wages, what is meant by, 279 ; time and 
piece, 279-280; relation between regu- 
larity of work and, 280-281 ; conditions 
of employment and, 281-282 ; the 
family wage, 282 ; real wages, 282-283 ; 
relation of, to labor cost, 283-284; and 
output, 284-285 ; and trade imionism, 
285-288; three theories as explanations 
■ of, 289 ; subsistence theory of, 289-291 ; 
wages fund theory of, 291-293 ; produc- 
tivity theories of, 293-301 ; influence on, 
of the standard of life, 301-307 ; in- 
fluence on, of volume of national divi- 
dend, 308-309; influence on, of in- 
equality of opportunity, 309-311 ; rent 
elements in, 341-345. 

Wasting of wealth, 404-406. 

Wealth, inequahty of, a cause of inequaUty 
of opportunity, 61-62 ; circulation of, 
214 ff. ; involved character of, 214; 
income and, 214-215; characteristics 
of, 215; nature of production of, 216; 
production of immaterial, 216-217; 
the immaterial elements in, 218; in- 
come as measure of, 218-220; necessity 



for replacement of, 220-221 ; and social 
service, 371, 377-383; definition of, 
389-390; as the object of economic 
organization, 390-391 ; method of meas- 
uring, 391-392 ; practical difficulties in 
measuring, 392 ; used in the sense of 
welfare, 393-395 ; defects in usual 
method of computing a covmtry's, 396- 
400; influence of use of, on welfare, 
404-406; welfare regarded as inde- 
pendent of, in some systems of morality, 
418-420; materialistic tendency of 
modem economic influences shown by 
habitual pursuit of, 431-433; how 
wealth contributes to welfare, 434-438. 

Wealth standards, present-day dependence 
on, 433. 

Weighted averages, 197. 

Welfare, wealth used to denote, 393-394 ; 
different conceptions of, 394-395 5 eco- 
nomic influences on, 401 ff . ; influence of 
distribution, 401-404; influence of use 
of wealth and kind of product, 404-406 ; 
influence of work, 408-411 ; sacrifice of 
producer to product, 411 ff. ; recogni- 
tion of relation between work and, 415- 
417 ; regarded as independent of wealth 
in some systems of morality, 418-420; 
question as to whether an economic 
consideration, 420-421 ; difficulty of 
determining, 423 ; how wealth con- 
tributes to, 434-438. 

Work, regularity of, and wages, 280-281 ; 
importance of object of, 408-409; the 
nature of its process, 409-410; the 
nature of its control, 410-41 1 ; develop- 
ment of worker's personality by, 413- 
414; importance of nature and condi- 
tions of, 414-415; recognition of rela- 
tion between welfare and, 415-417. 



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